Accounting and Financial Statement Basics

The Flow of Funds

  • The flow of money or funds goes upstream from customer to producer and from producer to supplier as intermediate or final products or service are paid for.
  • This funds flow is not linear since some upstream payments may occur long before the final good or service is even purchased.

Why is it critical to improve the flow of funds within a supply chain? There are several advantages to better flows:

  • It reduces cash-to-cash cycle time.

    (Definition) Cash-to-cash cycle time is an indicator of how efficiently a company manages its assets to improve the speed or turnover of cash flows.

    What is considered a normal duration for cash-to-cash cycle time will differ by supply chain, industry and organizational strategy.

    It is not necessarily possible to compare cycle times without understanding the relevant strategies for each business. However, an organization’s cycle time is a bench mark for its own continuous improvement.

  • The improved turnover of funds improves customer-supplier relationships through lower perceptions of risk, improved reliability and better communications which in turn tend to further improve relationships, yielding a win-win situation throughout the supply chain.
  • Improved cash flow tend to reduce imbalances between the layer and smaller players in the supply chain. Consistent rules for integrated cash flows across the supply chain help avoid the situation in which sizable retailers request more liberal payables terms from manufacturers and large manufacturers do the same with their smaller suppliers.

Spend Management

  • The initial efforts in supply chain management focused primarily on cutting costs because the supply chain constituted one long cost center. It was all about removal of waste, time, unnecessary motion, defects and extra costs.

(Definition) Spend Management is managing purchases of goods and services in a supply chain, including outsourcing and procurement activities.

  • Spend management often deal with consolidating internal demand across business functions, divisions or extended partners and/ or consolidating suppliers to find areas of purchasing and transportation quantity rate discounts.
  • Relative to financial performance, spend management involves managing the outflow of funds in order to buy goods and services. Spend management may also need to coordinate closely with accounts payable because payment timing is vital to spend management execution.
  • While spend management is used by supply chain managers to control external costs, many organizations use a system such as standard costing to control internal costs related to the goods or service being produced.

Standard Costing

(Definition) Standard Costs are the target costs of an operation, process or product, including direct material, direct labor and overhead charges.

(Definition) Standard Costing or Standard Cost Accounting System is a cost accounting system that uses cost units determined before production for estimating the cost of an order or products. For management control purposes, the standards are compared to actual costs and variances are computed.

Standards are targets that the organization sets to show the expected or desired outcome of an activity. These are periodically reviewed and changed as needed.

Some additional terms in standard costing:

  1. Cost of Goods Sold (COGS)

    An accounting classification used for determining the amount of direct materials, direct labor and allocated overhead associated with the products sold during a given period of time.

  2. Current Price

    The price currently being paid as opposed to standard cost. A related term is marked price, which is going price for an item on the open market.

  3. Usage Variance

    Deviation of the actual consumption of materials as compared to the standard.

  4. Cost Variance

    In cost accounting, the difference between what has been budgeted for an activity and what it actually costs.

Each cost has two components that are set as standards: Volume and Rate.

Cost = Volume X Rate
Direct Material Costs = Qty. Purchased X Unit Cost
Direct Materials Used = Qty. Used X Unit Cost
Direct Labor Cost = Standard Hours X Hourly Rate
Overhead Cost = Cost Driver X Total Overhead
Total Cost Driver

Volume: It is how many units of resource is purchased or used.

Rate: It is the cost per unit of that resource.

  • When volume has variances from the standard, it is a usage variance.
  • When the rate has variances, it is a cost variance.
  • Both variances are tracked separately and their sum should equal the total variance. Variances can be positive or negative. Negative variances occur when costs are greater than expected; positive variances occur when costs are less than expected.
  • Overhead costs are allocated costs based on a cost driver. A cost driver is simply a measurable aspect of an operation that is used to approximate how much of the overhead should be associated with the units produced.
  • A frequently used cost driver is direct labor hours.

Uses of Standard Costing

  • Standard costing is used to estimate the cost of goods sold before all costs are known with certainty. It also provides benchmark targets for use during production. Thus it is a method of controlling a process during production rather than only being applied by documenting after production is complete.
  • Inventory can be valued using standard costing, although other methods also exist.
  • If standard costing is used at an organization, efficiency can be calculated using a formula:

Efficiency = (Standard Hours of Work / Hours Actually Worked) X 100%

Financial Statements

Financial statements help managers and investors track the financial results of an organization’s activities.

Balance Sheet

(Definition) A financial statement showing the resources owned, the debts owned and the owner’s share of a company at a given point in time.

  • The balance sheet is often called “snapshot” of the company’s financial position, because it is a static view of financial value or net worth at a point in time, usually the last day of the fiscal year, though it could also be for the end of any reporting period, such as month or quarter. It gets its name from the fact that it has two major sections that have to be in balance – assets on the one hand and liabilities and owner’s equity on the other.

Assets = Liabilities + Owner’s Equity

  • The balance sheet sections are always in balance because owner’s equity is simply the difference between assets and liabilities.
  • The balance sheet shows the increase or decrease in assets, liabilities and owner’s equity from year to year.

(Definition) Accounts Receivable are the value of goods shipped or services rendered to a custom on which payment has not yet been received and usually includes an allowance for bad debts.

(Definition) Accounts Payable are the value of goods and services acquired for which payment has not yet been made.

  • These two balance sheet amounts are used to calculate the cash-to-cash cycle time, which measures how many days the organization’s working capital is invested in managing the supply chain.

(Definition) Working Capital is the current assets of a firm minus its current liabilities.

  • Working capital is important to the supply chain because these are the funds the organizations has readily available to invest in normal operations.

Income Statement

(Definition) A financial statement showing the net income over a given period of time.

  • Income statement is cumulative and dynamic, meaning that the statement covers business results over a period of time, such as a quarter or a year, rather than being a static snapshot.
  • The income statement shows managers, investors and creditors whether the company has made or lost money during the given period of time.

Income = Revenues – Expenses

  • These are the key terms to be familiar with:
    • Profit

      It is money remaining from revenues after deduction of certain expenses.

    • Profit Margin

      It is the difference between the sales and cost of goods sold…sometimes expressed as percentage of sales.

      This measures the degree of financial success for a business.

    • Gross Profit Margin

      It is the difference between total revenue and the cost of the goods sold.

    • Net Profit

      It is figured by deducting all expenses, not only the cost of goods sold, from revenues.

  • Supply chain managers can use an income statement to determine the effect of supply chain expenses on net income.
  • Operating expenses such as sales bonuses or general and administrative expenses (all cost that cannot be linked to specific unit sold) are called period costs because they must be expensed in the period in which they are incurred.
  • COGS are called product costs. Product costs are accounted for in the period in which the units are sold even though many of these costs may be incurred in earlier periods.
  • Matching refers to reporting related revenues and expenses together in the period in which they were incurred. For example, sales expenses incurred to make a sales should fall in the period the sales was made. When they do not, accountants use adjustments called “accruals” to account for the period differences.

Statement of Cash Flows (Funds Flow Statement)

(Definition) A financial statement showing the flow of cash and its timing into and out of an organization or project (over a given period of time).

(Definition) Cash Flow is the net flow of money into or out of the proposed project organization. It is the algebraic sum, in any time period, of all cash receipts, expenses and investments.

  • There are three factors that determine cash flows:
    • Sales
    • After-tax operating profit margin
    • Capital requirements
  • The purpose of a statement of cash flows is to show lenders, investors and creditors whether the organization has sufficient cash to pay debts, bills and dividends to owners because cash, not net income, is needed to make these payments. The after-tax net income on the income statement is not the same as cash flow, but it is the starting point for the statement of cash flows.
  • Being able to read and understand a cash flow statement is important because it enables you to assess if the firm is:
    • Generating enough cash to fulfill its minimum obligations to lenders, investors and governments (taxes).
    • Generating extra cash that can be used to repay debt, purchase additional assets for growth or invest in new products.
  • This information is particularly helpful for financial managers, who use it along with a cash budget when forecasting their organization’s cash positions.
  • Depreciation is a predetermined incremental reduction in the value of fixed assets, such as property, plant and equipment on the income statement to account for their deterioration over time. This provides organizations a tax benefit to offset the investment in fixed assets.
  • Since depreciation reduces net income on the income statement but doesn’t reduce actual cash levels, depreciation is added back on the statement of cash flows to determine the actual cash flow.

Tax Savings and the Supply Chain

Paying less in taxes around the world translates into increased earnings per share.

Procurement and Taxes

  • Multinational corporations may decide to set up a central, global procurement and sourcing center.
  • In this way the supply chain benefits from various efficiencies created by consolidation of staff and equipment. If, in addition, the company locates the global facility in a low-tax region, the tax savings will magnify the savings from efficiencies of scale. This works because tax authorities generally levy taxes on separate streams of corporate income depending upon where they are earned. The global procurement center thus becomes subject to the tax policies of its country of residence.

Taxes & Logistics Networks

  • Organizations can also realize tax savings by combining tax planning with logistics reengineering projects.
  • While they are cutting lead times, reducing manufacturing costs and shaving transportation outlays they can also reduce their global tax liability by closing facilities in high-tax jurisdiction and moving them to countries with lower tax rates.

Taxes & Information Technology

A particularly intriguing tax-saving strategy is the purchase of supply chain software to improve planning and responsiveness. The cloud be an enterprise resource planning (ERP) system or a system with more limited application.

Competing Values

  • Whenever you are discussing supply chain financials, remember that each department in an organization has its own particular priorities based on its activities and those priorities may compete with each other.
  • For instance, the primary objective of marketing is to maintain and boost revenue and it strives toward that by providing great customer service.
  • Although the finance function is also interested in increasing revenues its primary focus is on keeping costs and investment expense low.
  • Production wants the lowest operating cost it can achieve. Those conflicting viewpoints may spill over into how each function views financial departments and metrics.

About Paresh Sharma

https://au.linkedin.com/in/itspareshsharma

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