Governance Risk Management & Compliance (GRC) Archives : Planergy Software

Vendor Analysis: What Is It, Process, Types, and Best Practices

Keith Murphy — Fri, 19 Jan 2024 15:12:42 +0000

Download a free copy of "Indirect Spend Guide", to learn:

Where the best opportunities for savings are in indirect spend.
How to gain visibility and control of your indirect spend.
How to report and analyze indirect spend to identify savings opportunities.
How strategic sourcing, cost management, and cost avoidance strategies can be applied to indirect spend.

Download Free Copy

Vendor Analysis: What Is It, Process, Types, and Best Practices

Category

Vendor Management

Written by Keith Murphy
19 min read

Tags

Governance Risk Management & Compliance (GRC)Sourcing Supplier Relationship Management

Last edited

January 19, 2024

Download PDF

KEY TAKEAWAYS

Choosing the right vendor for your needs should be based on criteria that align with your business needs and goals.
Taking your time throughout the process ensures you get the best possible match.
Vendor analysis is crucial for risk management.

As a procurement professional, you know the importance of ensuring that all materials and services delivered by vendors meet or exceed your standards for quality and performance.

That’s why vendor analysis is essential to any successful procurement process – it helps ensure that companies procure from reliable suppliers at competitive prices while adhering to applicable regulations.

In this blog post, we’ll explore vendor analysis, its underlying processes and types, and best practices when implementing this critical tool in your organization.

Read on to learn more about how effective vendor analysis can help you streamline your supply chain management efforts!

What is Vendor Analysis?

Vendor analysis evaluates and compares various suppliers based on their pricing, quality, reputation, reliability, and service delivery.

It’s an essential tool for businesses to identify the best suppliers for your business needs, and build strong, long-term partnerships with them.

This is usually incorporated into the broader supplier evaluation and selection process when onboarding new suppliers. But it will also be incorporated into regular supplier reviews to consider if they are still the right preferred vendor for the company to use.

The criteria used in vendor analysis can vary depending on the business’s needs.

Common factors include cost-effectiveness, quality of goods or services, delivery lead times, customer service, regulatory compliance, flexibility, technical expertise, and the supplier’s financial stability.

What is a Vendor Analysis Report?
A vendor analysis report is a document that summarizes the findings of the vendor analysis process. It typically includes information about the supplier’s strengths and weaknesses, potential risks, and opportunities for improvement.
What Does a Vendor Analyst Do?
A vendor analyst is responsible for conducting the vendor analysis. Their role involves researching potential suppliers, analyzing their offerings, and making recommendations to the business based on their findings. Vendor analysts are the people who conduct due diligence.
What Is Vendor Due Diligence?
Vendor due diligence refers to the process of investigating a supplier before entering into a business agreement with them. It’s crucial to ensure that the supplier can fulfill their obligations and that they align with your company’s values and goals.
Due diligence can help uncover potential issues, such as financial instability or legal troubles, that could impact the supplier’s ability to deliver.
It also provides valuable insights into the supplier’s operations, which can inform negotiation strategies and decision-making.
Vendor Analysis vs. Vendor Assessment
While both vendor analysis and vendor assessment aim to evaluate suppliers, there are slight differences between the two.
Vendor analysis is a more comprehensive process that involves a detailed evaluation of various aspects of a supplier.
On the other hand, a vendor assessment is usually a narrower process that focuses on assessing a supplier’s performance against specific criteria or standards.

The Vendor Analysis Process

This is a multi-step, in-depth business process designed to help you find the best vendor for your needs.

Selection Criteria
The selection criteria stage is where businesses identify potential vendors based on several factors:
- Reputation: Look at online reviews, ratings, and feedback from other customers.
- Quality: Assess the quality of products or services the vendor offers.
- Efficiency: Evaluate how efficiently the vendor can deliver their products or services.
- Capability: Determine if the vendor has the capacity to meet your business’s demands.
- Stability: Examine the vendor’s financial health to ensure stability and reliability.
Pre-Screening
Pre-screening is a preliminary step to narrow down potential suppliers:
- Background Checks: Conduct a thorough background check on the vendor. This includes checking their legal history, financial records, and media coverage.
- Customer Reviews: Review experiences from existing customers. This can provide valuable insights into the vendor’s reliability, customer service, and product quality.
Questionnaire
A questionnaire can help businesses get detailed information about the vendor’s operations:
- Processes: Ask about the vendor’s production processes, delivery timelines, and quality control measures.
- Security: Inquire about the vendor’s security protocols, especially if they handle sensitive data.
- Financials: Ask for details about the vendor’s financial stability, including their credit rating and financial statements.
- Policies: Understand the vendor’s policies on issues like returns, refunds, and customer service.
Based on the information you collect about your prospective vendors, you can create a shortlist of specific vendors you want to investigate further. Narrow it down to a few providers before moving to the next step.
Site Visit
A site visit allows businesses to get a firsthand look at a vendor’s operations:
- Operations: Observe the day-to-day operations of the vendor. This can give you an idea of their efficiency, organization, and work culture.
- Quality Control: Check the vendor’s quality control measures. This can include inspecting their facilities, equipment, and processes.
- Management: Meet with the vendor’s management team. This can provide insights into their leadership style and business philosophy.
Once you finish the site visits, you can move into narrowing down the list even further based on your findings. When you find a vendor or two that you’re most interested in working with, move into the negotiation phase.
Negotiation
The negotiation phase is where businesses discuss terms with the vendor:
- Pricing: Discuss pricing options. Aim for a price that is fair for both parties and sustainable in the long term.
- Terms and Conditions: Review the vendor’s standard terms and conditions. Negotiate changes if necessary to protect your business’s interests.
- Service Level Agreement (SLA): Define the level of service you expect from the vendor. This should include specifics about delivery times, quality standards, and response times for issues or queries.
- Exit Strategy: Discuss what will happen if the relationship needs to end. This should cover scenarios such as contract termination, transition of services, and resolution of outstanding issues.
At the end of the negotiation phase, you should know which vendor you want to enter into a contract with.

Vendor evaluation is an important part of the process for all projects – because you want vendors who can meet your needs, and have the financial strength to stay in business a long time.

Different Types of Supplier Analysis

There are different types of vendor analysis, each with its unique focus. For instance, a cost-based analysis looks at the supplier’s pricing structure, while a capabilities-based analysis evaluates the supplier’s ability to meet specific requirements.

Cost-Based Analysis
A cost-based analysis concentrates on the financial aspects of the deal, including suppliers’ pricing models, payment terms, and potential discounts or rebates.
It helps identify if a supplier is offering value for money and aids in comparing different suppliers’ pricing strategies.
Capabilities-Based Analysis
This analysis assesses a supplier’s ability to meet the specific needs of a business. This could include production capacity, technological capabilities, compliance with industry standards, and ability to meet delivery deadlines.
Performance-Based Analysis
This type of analysis evaluates a supplier’s past performance. It considers factors like delivery punctuality, error rate, responsiveness to issues, and overall reliability.
This is a good way to monitor how well a vendor meets your needs after working with them for a few months.
Strategic Analysis
This analysis looks at a supplier’s strategic value to the business. It evaluates the potential for a long-term relationship, the supplier’s position in the market, and the risk and opportunities associated with the supplier.
Vendor Risk Analysis
This analysis identifies potential risks associated with a supplier. These could be financial, operational, reputational, compliance-related, or supply chain risks. It’s crucial to ensure the business is prepared for any negative impacts a supplier could have.

Each type of vendor analysis provides valuable insights, and businesses often employ a combination of these to make the most informed decisions.

Best Practices for Effective Vendor Analysis

Involve Key Stakeholders
Involving stakeholders in the vendor selection process is not just important; it’s crucial for the success of any business project.
Stakeholders can include anyone who has an interest in the project or will be affected by its outcome, such as employees, managers, customers, and investors.
Each stakeholder brings a unique perspective and set of expertise to the table, which can greatly enhance the decision-making process.
Including stakeholders in vendor selection ensures that all relevant viewpoints are considered. For instance, while a procurement team might focus on cost, a product manager may prioritize quality, and a customer service representative might emphasize reliability.
By incorporating these diverse perspectives, businesses can make more informed and balanced decisions aligning with their strategic objectives.
Involving stakeholders also fosters a sense of ownership and commitment to the project. When stakeholders are part of the decision-making process, they are more likely to support and actively contribute to successfully implementing the chosen vendor solution.
This cross-functional collaborative approach can lead to better project outcomes, increased stakeholder satisfaction, and stronger vendor relationships.
Use a Vendor Management System to Track Everything
A vendor management system (VMS) can be an invaluable tool in managing supplier performance reviews and maintaining relationships.
This system provides a centralized platform where all relevant procurement and vendor data about a supplier’s performance can be stored, tracked, and analyzed.
Vendor management key performance indicators such as delivery times, quality of goods or services, responsiveness to issues, and cost-effectiveness can be monitored in real-time, providing you with actionable insights into each supplier’s performance.
To conduct a supplier performance review using a VMS, set up the key metrics that matter most to your business.
The system will then continually track these metrics, providing real-time updates. When it’s time for a review, the VMS can generate comprehensive reports detailing the supplier’s performance, highlighting areas of strength and those needing improvement.
But a VMS isn’t just for tracking and reviewing performance; it’s also a powerful tool for maintaining and enhancing supplier relationships.
Providing transparent feedback based on concrete data encourages open communication between you and your suppliers. You can work together to address any issues, improve performance, and optimize processes.
Moreover, recognizing and rewarding high-performing suppliers can strengthen relationships and foster long-term partnerships. In this way, a VMS can play a pivotal role in managing and enhancing your supplier relationships.
Choose Metrics to Evaluate All Suppliers Against
Choosing the right metrics to evaluate your suppliers is the first step toward effective supplier management.
These metrics allow you to objectively measure and compare supplier performance, helping you identify the best suppliers for your business.
What you choose will depend on your business model and goals, what product or service you’re trying to procure, and the type of analysis you’re conducting.
These metrics are important because they directly impact your business’s ability to provide high-quality products or services to your customers.
However, the importance of each metric may vary depending on your business’s specific needs and goals and the nature of your industry.
Leverage Vendor Scorecards to Compare Results
Vendor scorecards are a powerful tool for evaluating and comparing suppliers. They provide a standardized format for collecting and displaying data on various qualitative supplier performance metrics, enabling you to quickly and easily assess supplier performance.
A vendor scorecard might include data on:
- Product or Service Quality
  Measured by defect rates, specifications compliance, and customer feedback.
- Delivery Performance
  Measured by factors such as on-time delivery rate, order accuracy, and flexibility in handling changes or emergencies.
- Cost Competitiveness
  Measured by factors such as price competitiveness, cost savings achieved, and payment terms.
- Customer Service
  Measured by factors such as response time, problem resolution efficiency, and communication quality.
Using vendor scorecards has several advantages over other supplier evaluation methods.
It provides a clear, visual representation of supplier performance, makes it easy to compare different suppliers, and allows for ongoing tracking of supplier performance over time for easier and faster decision-making.
Analyze Your Current Suppliers – Not Just New Ones
While it’s important to thoroughly evaluate potential new vendors, it’s equally important to continuously analyze your existing suppliers.
This helps ensure that they continue to meet your performance standards and allows you to address any issues before they become significant problems.
Regular supplier analysis can involve:
- Regular Reviews: Conduct regular reviews of supplier performance based on your chosen metrics.
- Feedback Sessions: Provide feedback to suppliers on their performance and discuss any areas for improvement.
- Continuous Improvement Plans: Work with suppliers to develop and implement plans for continuous improvement.
Take Your Time – Do Not Rush Vendor Selection
Choosing the right vendor is not just about finding the most cost-effective solution; it’s about ensuring that you receive high-quality services that meet your specific needs and contribute positively to your business’s overall productivity and efficiency.
Rushing into vendor selection without proper due diligence can lead to subpar results, increased business risks, and potential losses in the long run.

Vendor Performance and Evaluation Can Make or Break Your Business

Regularly evaluating supplier performance is an essential part of any successful business.

It helps identify improvement areas, provides insight into how the vendor can better meet your needs and can improve long-term supplier relationships.

Regular evaluations should be performed by a knowledgeable individual familiar with the services being provided. The evaluation should include feedback from multiple departments or sources to ensure that all relevant data is considered.

Download PDF

What’s your goal today?

1. Use Planergy to manage purchasing and accounts payable

We’ve helped save billions of dollars for our clients through better spend management, process automation in purchasing and finance, and reducing financial risks. To discover how we can help grow your business:

Read our case studies, client success stories, and testimonials.
Visit our Vendor Management Solutions page to see how Planergy can help strengthen relationships with keys vendors, monitor performance, and ensure vendor compliance. .
Learn about us, and our long history of helping companies just like yours.

2. Download our “Indirect Spend Guide”

Download a free copy of our guide to better manage and make savings on your indirect spend. You’ll also be subscribed to our and notified about new articles or if have something interesting to share.

3. Learn best practices for purchasing, finance, and more

Browse hundreds of articles, containing an amazing number of useful tools, techniques, and best practices. Many readers tell us they would have paid consultants for the advice in these articles.

The post Vendor Analysis: What Is It, Process, Types, and Best Practices appeared first on Planergy Software.

Accounts Payable Policy: What Is It, Best Practices, and an Example Template

Mary Girsch-Bock — Thu, 01 Jun 2023 12:18:20 +0000

Download a free copy of "Preparing Your AP Department For The Future", to learn:

How to transition from paper and excel to eInvoicing.
How AP can improve relationships with your key suppliers.
How to capture early payment discounts and avoid late payment penalties.
How better management in AP can give you better flexibility for cash flow management.

Download Free Copy

Accounts Payable Policy: What Is It, Best Practices, and an Example Template

Category

Accounts Payable

Written by Mary Girsch-Bock
20 min read

Tags

Best Practices & Tips Governance Risk Management & Compliance (GRC)Invoice Processing

Last edited

July 2, 2024

Download PDF

What Is an Accounts Payable Policy?
What Are the Functions of Accounts Payable?
What Is the Typical AP Process?
What Are Internal Controls for Accounts Payable?
What Is an Accounts Payable Write-Off Policy?
Best Practices for Creating an Effective Accounts Payable Policy & Procedures Manual
Accounts Payable Policy Template
Steps to Create an AP Policy and Procedure Manual
What Should be Included in Your Accounts Payable Policy and Procedures Manual
Accounts Payable Best Practices for Your Business

Creating and having staff adhere to set policies helps establish guidelines for completing tasks by setting parameters that can be useful for business operations.

That’s why creating and maintaining a consistent accounts payable policy is so important to your business.

Setting accounts payable policies can help ensure that consistent policies are used across the board.

A comprehensive accounts payable manual can also serve as a training document for new employees and can easily answer routine questions staff may have throughout the AP process.

What Is an Accounts Payable Policy?

An accounts payable policy is the guidelines that are put into place to ensure that AP processing is completed on time and accurately.

Accounts payable policy looks at all aspects of your current AP system and creates a policy around those procedures.

For example, an AP policy may state that all invoices need to be approved by two employees or that invoice discrepancies need to be handled by a specific designee.

What Are the Functions of Accounts Payable?

The primary function of the AP department is to review, manage, and pay for goods and services received from vendors and suppliers in a timely manner.

But the accounts payable department is also responsible for finding new vendors and suppliers, vetting them, and maintaining a good business relationship with them.

Accounts payable is also responsible for providing accounting with all necessary AP reports.

Finally, the account payable department is responsible for ensuring that all original invoices match purchase orders and shipping receipts.

What Is the Typical AP Process?

The typical basic accounts payable process consists of four steps:

Receiving the supplier or vendor invoice
Reviewing the vendor name, account number, and invoice number for accuracy and completing the three-way match process if using a purchase order or procurement system
Approving the invoice for payment
Paying the invoice

If you’re using a procurement system, you’ll also want to include steps used in the procurement process as well, covering full cycle accounts payable.

What Are Internal Controls for Accounts Payable?

Internal controls for accounts payable cover four areas:

Obligation to Pay

Obligation to pay controls include purchase order approval and/or invoice approval, three-way matching, which matches invoice numbers, purchase order numbers, and shipping receipts, and regular auditing for errors and duplicate payments.
Data Entry

Date entry controls include when to record the invoice, invoice number guidelines, and proper recording of the expense in the appropriate GL account.
Invoice Payment

Established payment controls should always include separation of duties, manual check signing guidelines, tracking check numbers, and guidelines for storing checks securely.

Invoice payment guidelines should also include instructions for paying invoices electronically via ACH or wire transfer.
Fraud Controls

Many of the internal controls instituted in AP are designed to reduce payment fraud and procurement fraud.

Additional checks might include reviewing invoices with missing data more carefully and querying invoices from unrecognized email addresses.

Internal controls are important in AP, as they help to reduce fraud while streamlining the entire AP process.

Establishing internal controls will also increase accuracy, minimize risk, and keep staff members accountable for their actions.

What Is an Accounts Payable Write-Off Policy?

Creating a policy for writing off accounts payable is important, as the International Financial Reporting Standards, or IFRS-9, lists two conditions when accounts payable may be written off.

Cancellation of Liability

If a vendor waives the outstanding AP balance or if contract terms have not been met, you are allowed to write off the balance owed to that vendor or supplier.

This is done by reducing the amount of the current AP balance by the amount canceled, with the same amount credited to Other Income.
Expiration of the Contract or Term

This will only occur when a contract or specific payment term is in effect.

Once the payment term passes, the AP balance can be credited back to other income in the same fashion as explained above.

Write-offs are usually done at the end of the fiscal year.

Best Practices for Creating an Effective Accounts Payable Policy & Procedures Manual

When creating an accounts payable policy and procedures manual for your business, there are several best practices that you should follow.

Fully Document Policies and Procedures

Simply telling staff members what they’re responsible for or how to perform job tasks is inadequate. All policies and procedures should always be in writing.
Share and Make Easily Accessible to Appropriate Staff

An AP policy and procedure manual should be shared with all new and current AP staff, and easily accessible, which means the manual can be shared as a printed document or as an electronic file.
Review and Update Regularly

It’s important that the accounts payable manual be a working document that is regularly updated at least once a year, or when there is a major change.

When creating a policy manual, it’s important that the manual reflects the actual accounts payable process used in your business, including step-by-step instructions and screenshots, when appropriate.

It’s always better to make the manual too detailed rather than not detailed enough.

Accounts Payable Policy Template

Starting from scratch with a policy can be a daunting task.

Often it is easier to work from an existing template and edit it to suit your own business.

It can then be improved and updated over time.

The Macomb Township Accounts Payable Policy and Procedure document is a good example of what a completed policy may look like for smaller businesses.

Larger businesses may be better served by creating a larger document using a template like this one from the State of Victoria in Australia, which provides a general structure for a manual, allowing you to delete the areas that don’t apply to your business.

Steps to Create an AP Policy and Procedure Manual

If the thought of creating a manual is overwhelming, following these steps can help guide you through the entire process from initial creation to distribution.

You can create your manual outline from scratch or use some variation of the sample outline below.

Overview
- Responsibilities
Approval Process
- Invoices
- PO
Receiving Documents
- How they are sent to AP
- How they are stored in AP
Mail (postal, email, and fax)
- Sorting
- Review
Invoice Processing
- Where invoices should be sent
- The AP process for entering, reviewing, and scheduling payment
- Three-way matching or alternatives
- Handling disputed invoices
- Handling non-PO invoices
Payments
- Checks
- Printing
- Signing
- Mailing
- ACH
Credit card payments
- Wire transfers
Payment Policy
- Timing
- Early payment discount
- Late payment fees
Duplicate Payments

Chart of Accounts
- General ledger Coding
- Responsibility for GL Coding
Month end Accruals

Vouchers/ Check request forms
- Payment requests and check requisitions
Handling Lost checks
- Issuing stop payments
- Handling un-cashed checks
Master Vendor Policy

Dealing with Customer Inquiries

Statements
- Policy regarding paying from statements
- Requesting and reviewing vendor statements
Reports
- For management reporting
- For departmental evaluation
- For the staff
Collecting Vendor Taxpayer Number Information
- Policy for requesting W-9
- Payments to independent contractors
- Use of TIN Matching
- Issuance of 1099s
- Information reporting (to IRS)
- 1042
Internal Controls

Recordkeeping
- Record retention policy
- Filing supporting documentation
Petty Cash
- Policy
Reimbursements
- Disbursements
- Reconciliation
Travel expenses and travel reimbursements

Sales tax

Policy and Procedures Manual
- Responsibility for
- Updates
- Communicating policy to all affected parties
Businesses can easily add or eliminate areas that do not apply to their business when creating the manual.
Review the template to see if any items need to be added or removed from the list.
Assign personnel such as the department head to complete different parts of the manual.
Set a deadline to review the entire document.
Review the completed document with the appropriate personnel for accuracy and to make any changes.
Once changes are made, save the document and distribute it as a printed copy or as an electronic file.
Plan on reviewing each calendar year or when any major changes are made in the department.

What Should be Included in Your Accounts Payable Policy and Procedures Manual

Whether you’re creating a manual from scratch or using a template, there are some topics that you’ll want to include in your AP Policy Manual.

These topics include the following:

Department Overview

The overview should always outline the department structure and provide a detailed list of positions and what each position is responsible for.
AP Responsibilities

AP responsibilities vary from company to company. It’s helpful for auditing purposes as well as for AP team members to know exactly what the department is responsible for.
Procurement Responsibilities

If your business uses a purchasing or procurement system, you should also clearly spell out exactly what procurement is responsible for. Also, what are the policies related to issuing purchase orders.

For example, if your procurement department is responsible for vendor selection and vetting, that should be spelled out in the policy. Likewise, if your AP department typically handles this instead.
Approval Process for Purchase Orders

If you use purchase order software, you’ll need to spell out the approval process for purchase orders.

Is it based on dollar amounts, or are there specific employees designated for purchase order approval? And if a purchase order is approved, does the invoice still need to be approved?
Approval Process for Invoices

Specify which employees are responsible for approving invoices, and the process for ensuring that invoices are routed promptly.
Invoice Processing

Invoice processing should include details on when an invoice is entered (before or after approval), when it’s sent for approval, and what needs to be in place before routing the invoice for approval.

Invoice processing should also include details on three-way matching, and steps for invoice processing without a purchase order.
Handling Disputed Invoices

Policy should always include who is responsible for investigation and follow-up if an invoice is incorrect or pricing or product receipt is disputed.
Payment Policies

Establishing payment policies is essential for any AP department, with a clear delineation of responsibilities outlined.
Early Payment Discount

If your vendors regularly offer you early payment discounts, determine a timeline for ensuring that the discount can be utilized.
Handling Lost and Uncashed Checks

All businesses should have a policy in place to handle lost or uncashed checks.

These policies can include establishing a minimum time frame before a stop payment is issued on lost checks.
Collecting and Managing Vendor Data

Specify who is responsible for locating and managing vendor relationships.

This includes requesting W-9s, the payment process for independent contractors, and the issuance of year-end 1099s.
Record Retention Policy

Create and maintain a policy for record retention. Do you keep two years of vendor information in the office and place older years in storage? Whatever your policy is, be sure to spell it out.
Reconciliation

AP accounts should be regularly reconciled for accuracy. Determine whether the process should be monthly, quarterly, or yearly and assign personnel to complete the job.

Accounts Payable Best Practices for Your Business

Your newly created accounts payable policy and procedure manual should always reflect best practices.

These best practices should include the following.

Simplify Workflows with AP Automation Software

Using AP automation in your business can help you streamline the entire AP workflow process from invoice receipt to payment.

And for businesses that need a better way to manage AP expenses, implementing a procure-to-pay software that incorporates AP automation software, like Planergy, can help.
Establish Internal Controls for Your Business

Internal controls such as three-way matching and separation of duties are essential components for managing your AP department.
Strategically Manage Payments

Instead of paying by invoice date, pay by invoice due date.

This will allow you to use early payment discounts and take advantage of 30 to 45-day payment due dates to better use your available cash.
Negotiate Terms and Prices with Vendors and Suppliers

If you have a good relationship with your business partners, they may be agreeable to better pricing or more lenient invoice payment terms.

It only takes a minute to ask, and you may be pleasantly surprised by the outcome.
Keep the Lines of Communication Open

Problems or concerns should always be addressed with your vendors.

If you know a vendor or supplier’s payment is going to be late, letting them know will be more beneficial to your business relationship than remaining silent.
Automate Wherever You Can

AP automation isn’t an either/or prospect. If you’re reluctant to automate your entire accounting department all at once, there are plenty of applications on the market that can help you with the automation process.

There are options including OCR readers for automating invoice processing to AI and machine learning applications that automate the three-way matching process, it’s okay to start slow. It’s more important to just start.
Continue to Review AP Accounts Regularly

Whether you’re using a completely automated accounting system or are still using a manual system, it’s important to review and reconcile AP accounts regularly.

Doing so will help you identify potential trouble spots and correct any errors sooner rather than later. Busier AP departments may want to consider implementing a regular accounts payable audit.

Having a Current Accounts Payable Policy and Procedure Manual is Essential

Whether you’re a small business with a two-page manual or a large operation with a comprehensive manual, having a working set of procedures in place is key for an efficient and well-organized accounts payable department.

Download PDF

What’s your goal today?

1. Use Planergy to manage purchasing and accounts payable

Read our case studies, client success stories, and testimonials.
Visit our Accounts Payable Automation Software page to see how Planergy can automate your AP process reducing you the hours of manual processing, stoping erroneous payments, and driving value across your organization.
Learn about us, and our long history of helping companies just like yours.

2. Download our guide “Preparing Your AP Department For The Future”

Download a free copy of our guide to future proofing your accounts payable department. You’ll also be subscribed to our and notified about new articles or if have something interesting to share.

3. Learn best practices for purchasing, finance, and more

Browse hundreds of articles, containing an amazing number of useful tools, techniques, and best practices. Many readers tell us they would have paid consultants for the advice in these articles.

The post Accounts Payable Policy: What Is It, Best Practices, and an Example Template appeared first on Planergy Software.

Supply Chain Risks: Different Types and How To Mitigate Them

Lyle Del Vecchio — Thu, 26 Jan 2023 14:38:14 +0000

Download a free copy of "Indirect Spend Guide", to learn:

Where the best opportunities for savings are in indirect spend.
How to gain visibility and control of your indirect spend.
How to report and analyze indirect spend to identify savings opportunities.
How strategic sourcing, cost management, and cost avoidance strategies can be applied to indirect spend.

Download Free Copy

Supply Chain Risks: Different Types and How To Mitigate Them

Category

Spend Management

Written by Lyle Del Vecchio
16 min read

Tags

Governance Risk Management & Compliance (GRC)Supplier Risk Supply Chain Management

Last edited

July 2, 2024

Download PDF

Financial Risks

Risks in this category range from an unexpected change in the exchange rate to supplier bankruptcy. They can include funding limitations, missed or late milestones, and cost overruns and may be linked to changes in the project scope.

This can also include economic instability. Hanjin Shipping, the 7th largest shipping company in South Korea, went bankrupt and caused a 3% capacity reduction in the global supply chain. While that doesn’t sound like much, nearly $14 billion in cargo couldn’t dock.

What to Do About It

Establish an emergency fund to account for changes in exchange rates and cost overruns. Always have another supplier for any mission-critical raw materials in case there are issues of any kind with your primary suppliers.

When working with countries where economic uncertainty is an issue, work on increasing employment in the area with apprenticeships and reaching out to college students about careers in the supply chain.

Legal Risks

These often come from disputes regarding interpretations of contractual obligations, or not meeting requirements in the terms and conditions. Other legal risks include intellectual property misuse, especially concerning patents, civil lawsuits, and law violations.

What to Do About It

Consult with your legal team if there’s any doubt about an action the company or a representative may take.

Environmental Risks

This one is especially important for businesses focused on environmental, social, and governance (ESG) issues. The procurement team must always evaluate environmental risks created by contractors and suppliers.

Environmental risks cover any negative impact on the air, soil, or water due to emissions, discharge, and other kinds of waste.

What to Do About it

Evaluate suppliers based on their practices – paying special attention to any green initiatives they claim to have. Work with suppliers who are just as committed to protecting the environment as you are.

Source what you can from reclamation centers and use recycling whenever possible.

Natural Disasters

Everything from hurricanes to tornados and tsunamis can cause issues for ocean freight. As global warming and climate change cause more frequent and severe issues with tropical storms, it s more crucial to develop alternate routes.

What to Do About It

Re-evaluate using ocean routes and determine the carriers that can increase shipping in anticipation of storms, so you can be flexible enough to scale back operations in uncertain times.

Catastrophes

These include human-made issues, as well as natural disasters that aren’t a result of the weather, such as famine and earthquakes.

What to Do About It

Develop a detailed and solid plan to ensure continuity after a catastrophe. This could include devoting more resources to maintaining operations, using cloud-based tools, automation, and more.

Scope of Schedule Risks

These are most commonly the result of a poorly defined original scope of work, but they can negatively affect project timelines and lead to cost overruns.

Schedule changes may also result from natural disasters, including fire, flood, and hurricane. They may also arise because of noncompliance issues on behalf of the supplier.

Scope risk may also happen because of changes when the original statement of work (SOW) is no longer workable.

What to Do About It

Start with a clearly defined scope of work that all parties agree on.

Meet with involved parties to ensure there is no ambiguity, and have a contingency fund available in case budget overages occur due to something out of your control.

Sociopolitical Risks

When politics and government change drastically, it has the potential to wreak havoc on your current supply chain.

Take, for instance, Brexit, and its adverse effect on trade. Ultimately, this weakened the British pound’s value and created market volatility.

What to Do About It

Even in situations where governments don’t require a strict approach, maintain a high level of compliance across all operations.

Doing so reduces the risk of compliance violations and protects you against the enforcement of new regulations.

Shipping companies should opt to partner with carriers operating outside of the affected governments to handle trades.

Project Organization Risk

Also considered a planning risk, this occurs because you don’t have the right staff or tools in the right place at the correct time.

What to Do About It

Take extra time during the project planning phase to ensure you have a complete list of all the resources you’ll need to be successful with the project.

Consider staffing and equipment needs and what it will take to get what you need where you need it when you need it.

Human Behavior Risk

This is one of the most difficult areas to assess because people can be unpredictable.

Sometimes, a project may be pushed back because of injury, illness, or a key staff member deciding to leave the company. Other times, it could be because of bad decisions or poor judgment.

Beyond this, an assessment should identify internal risks (related to company operations) or external ones (related to conditions outside of the organization that are out of your control).

External risks could be regulatory, market fluctuations, changes in the political environment, etc.

What to Do About It

There’s not much you can do about the external factors, except have a plan to adapt to any changes as they arise.

The best thing you can do is focus on a plan to tackle the internal factors – having others on the project who can step up in the event of someone’s unforeseen absence.

Do what you can to take care of your employees and foster a great workplace culture to reduce turnover rates, and work to fill vacancies as quickly as possible with qualified applicants.

Supplier risk is always there, but using various risk management strategies can help you minimize the impact.

Connectivity

Today’s world is always on, but connectivity between systems can break, causing issues. You can integrate systems in various ways, but the more you integrate and customize, the higher your risk.

Every customization or modification could mean spending more for upgrades, and systems that aren’t integrated well could cause bottlenecks.

What to Do About It

Make sure your system connectivity relies on a secure network. Create data backups and decentralize your data storage. Remove as many system vulnerabilities as possible by encrypting personnel devices.

When you choose to integrate systems, avoid medications and work with experts to maximize efficiency, as this will help boost profitability.

Cyber Attacks

Cybersecurity should be a top priority as hackers could easily bring down your entire supply chain network, if they so choose.

Data breaches are also costly, and could lead to reputational damage on top of the costs of recovering from the attack and securing your systems to avoid future cyber attacks.

What to Do About It

Invest in top-of-the-line encryption and cybersecurity software. Beyond investing in a basic antivirus program, invest in tools like endpoint detection and response.

If you have remote employees, your risk increases, especially if they use their personal devices to access company information. Consider investing in company devices for your remote team to use so you have more control over the information that is accessed and shared.

Invest in cybersecurity awareness training to educate your staff about things like phishing and malware. This way, they know what to do if they suspect they received a phishing email or may have downloaded a suspicious attachment.

If this happens, endpoint detection can isolate the problem before it spreads to the rest of your network.

Transport Loss

The risk of losing goods in transport, or for shippers, losing the ability to transport goods always exists. Though it’s possible for shippers to create stronger networks and back up plans, it’s crucial for organizations to have a plan if the goods they were expecting don’t arrive on time, or arrive at all.

What to Do About It

Always insure your shipments against loss, to give yourself a safety net. Find the carriers that you work with most often and learn more about their contingency plans, and look for carriers you can use should they become unavailable.

Data Quality and Integrity

You need strong quality data for supply chain management, as the wrong data could leave you with missed opportunities and lower profits.

While you should be cautious about a data breach, sharing it with the right partner providers can help you grow and improve your business.

What to Do About It

Always validate your data for accuracy and timeliness because old data is useless. Invest in a real-time data monitoring system, so you can always trust your data and spot issues as they come.

Supplier Consistency

Less than half of suppliers can remain operational after a disaster. Disruption in consistency could happen as a result of any risk becoming a reality.

What to Do About It

The procurement department is fully responsible for supplier consistency, which is possible through a strong yet diverse supplier network.

Supply Chain Risk Management is Essential

No matter how likely any of these scenarios may be, it’s critical to have contingency plans for all of them.

As the pandemic showed us, things happen to shake things up at the global level, and companies that were prepared and could pivot quickly were the most successful regarding supply chain resilience and business continuity.

To avoid shortages, conduct supply chain risk assessments regularly.

These will help you see the most vulnerable areas, so you can create and implement a plan to address the vulnerabilities and protect the organization.

By understanding these supply risks, your procurement team can take appropriate action to respond to these risks as they arise.

Risk management needs to be a part of your company’s plans, and there are a lot of tools that can help you identify the risks that are unique to your organization.

From process improvement to strategic alliances and buffer strategies, the more prepared you are for anything, the better off you’ll be.

Of course, not all potential risks are included on this list – but risk mitigation strategies are a crucial part of success for all businesses.

Download PDF

What’s your goal today?

1. Use Planergy to manage purchasing and accounts payable

Read our case studies, client success stories, and testimonials.
Visit our Procurement Solutions page to see how Planergy can digitize and automate your procurement processes saving you time and money.
Learn about us, and our long history of helping companies just like yours.

2. Download our “Indirect Spend Guide”

3. Learn best practices for purchasing, finance, and more

Browse hundreds of articles, containing an amazing number of useful tools, techniques, and best practices. Many readers tell us they would have paid consultants for the advice in these articles.

The post Supply Chain Risks: Different Types and How To Mitigate Them appeared first on Planergy Software.

Financial Modeling Best Practices

Keith Murphy — Wed, 12 Oct 2022 14:33:48 +0000

Download a free copy of "Preparing Your AP Department For The Future", to learn:

How to transition from paper and excel to eInvoicing.
How AP can improve relationships with your key suppliers.
How to capture early payment discounts and avoid late payment penalties.
How better management in AP can give you better flexibility for cash flow management.

Download Free Copy

Download PDF

What is a Financial Model?

A financial model is a tool that can be used to predict the future financial performance of a company.

Financial models are typically used in business planning and decision-making, to assess the feasibility of new projects, or to evaluate the potential return on investment of an existing one.

Financial models are often used in conjunction with other analytical tools, such as market analysis and competitive intelligence, to give a complete picture of a company’s financial situation.

There are many different types of financial models, but all share some common features. A good financial model will be:

Accurate: The model should be based on sound assumptions and accurately reflect the data.
Relevant: The model should be relevant to the decision at hand.
Flexible: The model should be flexible enough to accommodate different scenarios and what-if analysis.
Understandable: The model should be easy to understand and explain to others.

6 Types of Financial Models

Six of the most often used types of financial forecasting models are:

Discounted Cash Flow Model

The discounted cash flow (DCF) model is a kind of financial model that values a company by forecasting future cash flows and discounting them back to present value.

The DCF model is a widely used valuation technique, but it has several disadvantages. The model is based on a number of assumptions, such as the discount rate, the length of the forecast period, and the company’s terminal value.

These assumptions can have a significant impact on the model’s results.

The DCF model only considers cash flows that are expected to be received in the future. This means that it does not take into account other important factors, such as earnings, dividends, or the value of assets.

The DCF model can be difficult to understand and interpret. This is because it relies on a complex formula that discounts cash flows over time.

The DCF model can be time-consuming and expensive to build. This is because it requires detailed financial information and a lot of data to be inputted into the model.
Comparative Company Analysis Model

The comparative company analysis (CCA) model is a type of financial model that values a company by comparing it to similar companies in the same industry.

The CCA model is a relatively simple valuation technique, but it has several disadvantages. The model is based on a number of assumptions, such as the size of the companies being compared, the similarity of their businesses, and the availability of data.

These assumptions can have a significant impact on the model’s results.

The CCA model only considers financial information that is publicly available. This means that it does not take into account important factors such as earnings, dividends, or the value of assets.

Like the DCF, the CCA model can be difficult to understand and interpret. This is because it relies on a complex formula that compares companies in different industries.
Sum-of-the-Parts Model

In a sum-of-the-parts model, the value of a company is the sum of the values of its individual business units. This type of model is commonly used to value conglomerates, which are companies that own a portfolio of businesses in different industries.

To build a sum-of-the-parts model, you will need to estimate the fair value of each business unit and then sum up these values to arrive at the total value for the company.
Leveraged Buy Out (LBO) Model

An LBO model is a tool used by private equity firms and investment banks to help them analyze leveraged buyout transactions.

Leveraged buyouts occur when a company is purchased using debt as well as equity. The use of leverage (debt) in an LBO increases the risk of the transaction, but it can also increase the potential return.

An LBO model is typically used to help assess the feasibility of a leveraged buyout transaction and to evaluate the potential return on investment.

The model will take into account the amount of debt used in the transaction, the interest rate on that debt, the expected repayment schedule, and the projected cash flow of the target company.

It is important to note that an LBO model is only as good as the assumptions that go into it. The model should be constantly updated and revised as new information becomes available.
Merger & Acquisition (M&A) Model

One of the most popular types of financial models is the merger and acquisition (M&A) model.

An M&A model is used to estimate the value of a target company in an acquisition scenario. The model is also used by investment banks to win new M&A business.

There are different ways to build an M&A model, but the key inputs are usually the same. These include:
- Purchase price
- Synergies
- Target company’s stand-alone value
- Financing mix
- Interest rates
- Tax rate
The purchase price is typically the starting point for an M&A model. This is the price that the acquirer is willing to pay for the target company.

The next key input is synergies. Synergies are the cost savings or revenue increases that can be achieved by combining the two companies. They are typically one of the main reasons for doing an acquisition.

The target company’s stand-alone value is the value of the company if it were not being acquired. This is estimated using a discounted cash flow (DCF) model.

The financing mix is the mix of debt and equity that will be used to finance the acquisition. The interest rate is the cost of borrowing for the acquirer.

The tax rate is the percentage of income that will be paid in taxes. This is a key input because it affects the after-tax return on investment for the acquirer.

After all of these inputs have been estimated, the M&A model will generate a value for the target company. This value can be compared to the purchase price to see if the acquisition makes sense from a financial perspective.
Option Pricing Model

Option pricing models are mathematical models that are used to determine the theoretical value of an option. These models take into account factors such as the underlying asset’s price, volatility, time to expiration, and interest rates.

The most popular option pricing model is the Black-Scholes model. This model was first published in 1973 by Fischer Black and Myron Scholes.

Other option pricing models include the Binomial model and the Trigeorgis model.

Option pricing models are used by traders to determine the best time to buy or sell an option. They are also used by investors to determine whether an option is fairly priced.

How To Make a Good Financial Model

A good financial model needs to be easy and efficient to use, review and understand. To benefit the company it needs to create insights and outputs that are relevant and actionable for the company. Here are some steps to help ensure you are creating a good financial model.

Start by Building a Model That Is Simple and Easy To Understand

A good financial model is one that is simple and easy to understand. The best way to achieve this is to start by building a model that is easy to follow. A good rule of thumb is to build the entire model from scratch, so that you can see how each piece fits together.

This will help you understand the relationships between the different elements of the model, and how they all work together.

A good financial model includes the following sections: assumptions and drivers, income, balance sheet, and cash flow statement. It should also include supporting schedules and sensitivity analysis. You can also include graphs and charts to visually represent the results of your model.

Financial models are vital tools used by professionals in a variety of industries. For example, bankers use them to conduct due diligence and valuations. They can also be used for portfolio management.

A financial model should also be dynamic. It should consider the relationships between the relevant factors. It shouldn’t assume a perpetual growth rate higher than the GDP of the domestic country.
Use Assumptions That Are Realistic and Conservative

When you’re model building, to get the most accurate information, always use conservative, realistic assumptions. If your assumptions are too far away from the most likely scenarios, then the model data won’t be useful.

Financial models should reflect key business assumptions in a clear, concise, and defensible manner. They should also reflect projected performance in a way that is easily understandable and flexible.

Using assumptions that are conservative and realistic is crucial in making a financial model that can be trusted.
Make Sure Your Inputs and Outputs Are Clearly Labeled

Clearly labeling inputs and outputs is crucial to keeping data consistent. Ideally, you’ll structure your model so that you only have to enter the data once. Start with historical data, such as income statements and other financial statements.

To make it easier to understand the difference between your inputs and outputs, use a consistent color coding system. For example:
- Blue: Assumptions, inputs, and drivers
- Black: Formulas and calculations with references to the same worksheet
- Green: Calculations and references to other Excel spreadsheets
- Red: References to separate files or external links

Taking a financial modeling course can help you ensure you build quality models to analyze various scenarios.

Financial Modeling Best Practices

Building a financial model can be tricky, below are a few best practices to follow to ensure your models are accurate, insightful, and usable.

Clarify the Problem and Set the Goal

A financial model should not contain the same assumptions or data twice, and it should be consistent from sheet to sheet. Changing an assumption should automatically change outputs throughout the entire sheet.

For example, a bakery that wants to buy a candy company may use a complex merger financial model to justify the price of the new combined entity.

Another example might be a company looking to pitch to investors and needs to show its economy of scale and growth.

Regardless of how complex the model is, its key components should be simple and easy to understand. Modeling is a process, and it should be done as efficiently and accurately as possible.

For best results, the process should be iterative. This is because mistakes and omissions can occur during model building.
Keep the Model as Simple as You Can

Use simple language and avoid confusing technical terms. The basic structure of a financial model will contain inputs, processing methods, and outputs. The model should also have a table of contents that can guide users through the model.

In a spreadsheet, it is advisable to use a single formula per row. This means that the formula in the first cell of each row should be the same as the formula in the rest of the row.

In this way, users will be able to understand the structure of the model. Although this may seem obvious, this practice is often violated. For example, spreadsheets often have multiple rows, and different formulas for each column.

The purpose of financial modeling is to forecast the financial performance of a business. It is an analytical process based on historical performance and assumptions about future revenue and expenses. It is a tool that helps operators of a business make data-oriented decisions.
Plan the Model Structure

Many big companies and investment banks use Microsoft Excel to plan their financial models. Make sure you color code your cells, set up error checks, conditional formatting and data validation, follow a consistent row and column structure, and use one formula per line.

Financial models should be easy to read. The formulas should be easily understood by non-modelers. Use colors such as blue for constants in the model, and green for cross-references among different sheets.

You should also plan the presentation of your financial model. This way, you can ensure that others will understand it easily.
Use Accurate Data and Protect Its Integrity

Every model needs accurate data – and using Planergy for spend analysis can ensure you have the correct spend data to begin with. If you have inaccurate data, you’ll get poor quality insights.
Use Dummy or Test Data

Before implementing your model for decision-making, start with test or dummy data to put the system through a stress test. When you know it works, move it to active use with current data.

Best Financial Modeling Software

There are many options when it comes to financial modeling software. The best choice for your company will depend on the features and level of support you need. Here is a list of some of the best options.

Finmark
Finmark offers flexible financial modeling software that is easy to use. It is great for startups and established companies alike, and it can help users build and manage custom models.
It allows users to create and compare multiple scenarios and track important metrics such as revenue and expenses. It also offers customizable formulas and reusable variables.
Excel
Excel is a powerful financial modeling tool but it has its own limitations. It can be difficult to handle multiple projects at once. Excel requires skilled programmers to manage the workflow. Many Excel users end up with jumbled spreadsheets.
Moreover, Excel has serious limitations when it comes to the accuracy of a financial model. Using an Excel-based financial model has cost companies billions of dollars. There are good reasons for finance teams love/hate relationship with Excel.
Jirav
Jirav can help streamline the process of budgeting, forecasting, and reporting. It also allows users to make adjustments and automatically roll forward their plans.
Jirav’s cloud-based financial planning and analysis software also allows users to work with consolidated data. Jirav also improves the security and collaboration of planning and analysis.
Cube
Cube is a great solution for small to mid-size businesses. Cube’s simplified interface makes it easy to use and is a good choice for those who have had experience with spreadsheets. It also provides enterprise-grade technology at a reasonable price.
You can even integrate Cube with Google Sheets, which further reduces the learning curve.

Why Financial Modeling is Important for Your Organization

Financial modeling is important for your organization because it:

Helps you make informed decisions about the future of your company.
Allows you to see how different decisions will impact your bottom line.
Helps you assess the feasibility of new projects.
Evaluates the potential return on investment of an existing project.
Gives you a complete picture of your company’s financial situation.

Download PDF

What’s your goal today?

1. Use Planergy to manage purchasing and accounts payable

Read our case studies, client success stories, and testimonials.
Visit our Spend Analysis Software page to see how Planergy can empower you to get more value from your spend.
Learn about us, and our long history of helping companies just like yours.

2. Download our guide “Preparing Your AP Department For The Future”

Download a free copy of our guide to future proofing your accounts payable department. You’ll also be subscribed to our and notified about new articles or if have something interesting to share.

3. Learn best practices for purchasing, finance, and more

Browse hundreds of articles, containing an amazing number of useful tools, techniques, and best practices. Many readers tell us they would have paid consultants for the advice in these articles.

The post Financial Modeling Best Practices appeared first on Planergy Software.

Business Fraud: How To Identify and Prevent It

Mary Girsch-Bock — Fri, 02 Sep 2022 15:55:52 +0000

Download a free copy of "Preparing Your AP Department For The Future", to learn:

How to transition from paper and excel to eInvoicing.
How AP can improve relationships with your key suppliers.
How to capture early payment discounts and avoid late payment penalties.
How better management in AP can give you better flexibility for cash flow management.

Download Free Copy

Business Fraud: How To Identify and Prevent It

Category

Finance

Written by Mary Girsch-Bock
15 min read

Tags

Best Practices & Tips Governance Risk Management & Compliance (GRC)Invoice Processing

Last edited

April 16, 2024

Download PDF

What Is Business Organization Fraud?

Business organization fraud can be as straightforward as an employee helping themselves to petty cash, to your chief financial officer running a scam. In general, corporate fraud schemes generally fall into these common categories:

Asset Misappropriation

This includes stealing, falsifying expense reports, and stealing non-cash assets.

Asset misappropriation accounts for the majority of fraud cases annually and can include stealing petty cash, making unauthorized purchases on a company credit card, or transferring money from a company bank account into a personal account.

Asset misappropriation can also include stealing office equipment, inventory, or supplies.
Payroll Fraud

Payroll fraud includes submitting inaccurate time sheets, paying unauthorized or fraudulent overtime, or paying unauthorized bonuses.

Though payroll fraud is most likely committed by the payroll department, there are many known cases of employees or even departments submitting inaccurate overtime hours and bonuses for payment.
Financial Statement Fraud

Though financial statement fraud is relatively rare, it usually occurs with publicly held companies that purposely withhold details on their financial statements.

However, this can also happen with smaller businesses that try to produce fraudulent financial statements to obtain a loan.

Financial statement fraud can carry substantial penalties, including returning any loans obtained under fraudulent pretenses, and even a prison sentence, particularly if the loan was from the federal government.
Tax Fraud

Tax fraud can be directly tied to financial statement fraud, with owners doctoring financial statements to avoid paying taxes. Of course, not paying taxes at all, or tax evasion is also considered a crime, with significant repercussions courtesy of the IRS.
Corruption

a much more intricate scheme than the first two, corruption typical corruption charges include bribery and extortion. Usually seen in larger companies, corruption can occur when a high-level executive accepts bribes or funnels money without the knowledge or consent of others.

The best way to prevent business fraud is to put the necessary internal controls in place. Good fraud prevention measures can help reduce your fraud risk and keep your company safe from both internal and external financial crime threats.

What Is the Most Common Type of Fraud in Large Businesses?

According to the Association of Certified Fraud Examiners, the most common type of fraud found in large businesses is asset misappropriation.

Asset misappropriation simply means that employees are stealing funds or company assets. Typically, these are employees in high-level positions that have access to bank accounts and other company assets.

The best way to prevent asset misappropriation in your company is to implement internal controls that safeguard company assets.

It’s also helpful to observe your employees for any warning signs such as a change in attitude, or a sudden desire to work long hours when no one else is in the office.

What Is the Most Expensive Type of Fraud?

The most expensive type of fraud is financial statement fraud, with a median loss of nearly $600,000. Financial statement fraud occurs when fraudulent financial statements are created in an effort to mislead investors and lenders.

Though the Sarbanes-Oxley Act of 2002, which expands reporting requirements for publicly held businesses was created as a result of the shocking bankruptcy of energy giant Enron, there are companies that continue to try and game the system by creating false or altered financial statements.

One of the biggest contributors to white collar crime, financial statement fraud is typically found in publicly held businesses, though with recent loans available from the government due to Covid-19, small business owners have also been active participants in financial statement fraud.

Financial statement fraud does raise some red flags that should be investigated. Some of the things you should keep an eye out for:

An obvious surge in profit at year-end
A proliferation of bonuses paid based on performance alone
Revenue growth while cash flow remains low
Significantly out-performing the competition

Why Is Fraud in Small Businesses So Common?

Big businesses aren’t the only ones prone to fraud. Small businesses experience fraud much more frequently, though typically at a lower level.

For small businesses, the risk often lies in a lack of internal controls. In very small businesses, owners may not be familiar with accounting processes and procedures and may fail to implement controls simply because they have no knowledge of them.

Another risk in small businesses is having one employee do multiple tasks such as signing checks, processing payments, making bank deposits, and handling payroll.

Another risk is procurement fraud. While a low risk for smaller companies, once your company begins to grow, the risk of procurement fraud grows as well.

Here are a few areas where procurement fraud is likely to occur:

Kickbacks – this happens when employees collude with vendors to up the cost of a product and receive cash or goods in return.
Fake Vendors – If you don’t have a proper procurement process in place, including procurement software, you run the risk of paying fake vendors for products or services never received.
Inflated Bills – with the proper safeguards in place, it’s easy for employees to approve inaccurate or overly inflated invoices.

Ways to spot procurement fraud include consistently mismatched invoices, unusually low bids, and employee/vendor relationships.

Procurement isn’t the only area where small businesses are vulnerable. Embezzlement is another problem for small businesses and can be done in numerous ways, with the number one way simply not ringing up the sale and then pocketing the cash.

Skimming, usually found in all-cash businesses, is taking a percentage of the money from the total received.

Forged checks, altered checks, and even payroll fraud are just a few of the things that small business owners need to protect themselves against.

Identity Theft and Fraud in Small Businesses

In 2020 alone, there were almost 17 million cases of identity theft in the U.S. alone. But it isn’t only individuals that are at risk for identity theft. Small business owners have recently become the latest target, with a 46% increase in the number of business identity theft cases reported in 2020.

While larger businesses have more controls in place to prevent identity theft in the business, small business owners are often vulnerable to these attacks.

In most cases, thieves are after confidential business information such as a federal tax identification number, which allows them to impersonate the business, enabling them to open lines of credit, credit cards, or even obtain loans.

Business identity theft is not going away, so it’s important that small business owners become aware of the risks and put the proper security measures in place to prohibit thieves from obtaining their financial information.

The Best Way to Avoid Fraud?

The best way to prevent business fraud is to put the necessary internal controls in place. These steps should include some of these anti-fraud measures:

Segregation of Duties

Never have a single employee handle all of your accounting duties. If one employee enters new vendors and cuts checks, another employee should review the printed checks or ACH/electronic payments and sign the checks.

This may be difficult for very small businesses, but in cases where you don’t have enough employees to properly segregate duties, at the very least, you need to review all new vendor information and all payments made by the business.
Implement Three-Way Matching for Accounts Payable

The three-way matching process matches an invoice with a purchase order and shipment/receiving information. All three must match, or an investigation is necessary.
Investigate Financial Statement Discrepancies

When reviewing your financial statements, spend some time digging deeper into anything that looks amiss. Whether it’s an overstated expense or a lower-than-expected bank balance, take the time to dig deeper. While it may be nothing, you won’t know if you don’t look.
Do a Background Check on Your Employees

Sometimes simply checking references isn’t enough. Performing a criminal background check on potential new hires is important.

Just be aware that most cases of fraud involve someone without a criminal history, so a clean background isn’t a guarantee, nor a reason to not put additional safeguards in place.
Don’t Focus Only on Finances

There are other ways that employees can defraud your business, including stealing products and supplies and even sensitive information.

Make sure that all confidential documents are locked in a safe or away from the office, and shred any documents that you don’t want others to have.
Keep Computers Secure

If you don’t have the proper measures in place to keep your computer data secure, you open yourself to not only internal fraud, phishing scams, and business identity theft.

Whether your software is on your desktop or on the cloud, if the proper precautions aren’t taken, you make your company vulnerable both internally and externally to online scammers.

Business fraud isn’t going away anytime soon. But good fraud prevention measures can help reduce your fraud risk and keep your company safe from both internal and external financial crime threats.

Download PDF

What’s your goal today?

1. Use Planergy to manage purchasing and accounts payable

Read our case studies, client success stories, and testimonials.
Visit our Accounts Payable Automation Software page to see how Planergy can automate your AP process reducing you the hours of manual processing, stoping erroneous payments, and driving value across your organization.
Learn about us, and our long history of helping companies just like yours.

2. Download our guide “Preparing Your AP Department For The Future”

Download a free copy of our guide to future proofing your accounts payable department. You’ll also be subscribed to our and notified about new articles or if have something interesting to share.

3. Learn best practices for purchasing, finance, and more

Browse hundreds of articles, containing an amazing number of useful tools, techniques, and best practices. Many readers tell us they would have paid consultants for the advice in these articles.

The post Business Fraud: How To Identify and Prevent It appeared first on Planergy Software.

How To Avoid A Decrease In Cash Flow From An Increase In Operations

Rob Biedron — Tue, 21 Jun 2022 14:57:59 +0000

Download a free copy of "Preparing Your AP Department For The Future", to learn:

How to transition from paper and excel to eInvoicing.
How AP can improve relationships with your key suppliers.
How to capture early payment discounts and avoid late payment penalties.
How better management in AP can give you better flexibility for cash flow management.

Download Free Copy

How To Avoid A Decrease In Cash Flow From An Increase In Operations

Category

Finance

Written by Rob Biedron
18 min read

Tags

Cash Flow Governance Risk Management & Compliance (GRC)

Last edited

December 19, 2023

Download PDF

How To Avoid A Decrease In Cash Flow From An Increase In Operations

Operating cash flow refers to the cash flow your business generates from its regular activities. It begins with net income from your income statement, adds back in the cash, and then incorporates changes in working capital.

On a basic level, if you have the balance on asset increase, cash flow from operations decreases. If the balance on an asset decreases, you’ll have an increased cash flow.

If you have a net increase in balance on a liability, cash flow from operations increases. If the balance on the liability decreases, your cash flow decreases as well.

Ideally, your business should develop a strategy that avoids declines in cash from business operations. To do this, you must focus on maximizing your net income and optimizing efficiency ratios.

What Factors Decrease Cash Flow from Operating Activities?

Net Income Decrease

The cash flow statement (CFS) is a financial statement that provides a summary of how your business has moved its cash and cash equivalents (CCE) over an accounting period. You may also hear it referred to as a statement of cash flows. It is a statement accepted by the Generally Accepted Accounting Principles (GAAP) standards for financial reporting in accrual accounting.

The CFS indicates how well a business manages its cash position. in layman’s terms, this refers to how well the company generates revenue to pay its debts and fund its operations. It is one of three main financial statements and it complements the income statement and balance sheet.

The cash flow statement starts with net income which is equal to all revenue minus cost including income taxes. The operating cash flow on the other hand begins with net income and any changes in that income that would affect cash flow from operating activities. If your revenues decrease or your costs increase and cause your net income to decline, you will see a decrease in cash flow from operating activities.

Changes to Working Capital

The biggest part of the cash from operating activities is the changes in working capital which include your current assets and current liabilities. Changes in your current assets and liabilities are shown in the cash flow statement. Growth in assets or a reduction in liabilities from one period to another constitutes the use of cash and reduces your cash flow from operations.

Evaluate your working capital management with efficiency ratios like inventory turnover, days sales outstanding, and days payable outstanding, so you can see how your company’s operations influence the actual cash available.

Low Inventory Turnover Rates

Calculate your inventory turnover rate by finding the ratio of sales to the inventory available at the end of the same period. If you find a lower inventory turnover, this indicates less effective Inventory management. Improper inventory management increase is the level of inventory shown on the balance sheet at any given time, meaning that you’re not selling your inventory. This is a cash use that decreases cash flow from operations.

Inventory Changes

Whenever you have inventory changes, you’re affecting your cash flow. If you have an increase in inventory, you’re changing your current assets and, you’re damaging your cash flow. If you can decrease your inventory, you’ll have more cash flow. Inventory is typically the largest short-term asset of businesses that sell products rather than services.

Increase in Days Sales Outstanding

Days sales outstanding is a metric that measures how quickly your organization collects cash from its customers. Calculate this much work by multiplying the number of days in a period By the ratio of accounts receivable to credit sales across the same period. If you see the number increase, it indicates poor receivable collection practices so your company isn’t getting paid for items it has sold. Ultimately, you end up with higher current assets with a use of cash that decreases cash flow from operating activities.

Decrease in Days Payable Outstanding

Your accounts payable, or notes payable, are the amounts you owed to vendors that are payable within the next 30 to 90 days. Without payables and credit, you have to pay for all goods and services at the time of purchase. For optimal cash flow management, you need to take a closer look at your payable schedule.

Days payable outstanding measures how quickly your business pays your suppliers. To calculate it, multiply the days in the period by the ratio of accounts payable to the cost of revenues within the same period.

If you find a decrease in the days payable outstanding, your business is paying suppliers faster and money is going out the door sooner. It reduces accounts payable on your balance sheet. Reducing your current liabilities is the use of cash that decreases cash flow from operations.

Changes in Prepaid Expenses

If you encounter an increase in prepaid expenditures, your cash flow suffers. But if you encounter a decrease in prepaid expenses, you’ll improve your overall cash flow.

Net Changes in Accounts Receivable

Increasing accounts receivable hurts cash flow but decreasing helps it. Your accounts receivable asset indicates how much money customers who bought products on credit still owe your business. This asset is a promise of cash that your organization will receive but the cash will not increase until you collect money from customers.

Changes in Operating Liabilities

If you have an increase in short-term operating liability, you will see an improvement in cash flow. If you have a decrease in operating liabilities, your cash flow will decline.

Depreciation

When you record appreciation expenses, you’ll decrease the book value of your long-term operating assets. There is no cash outlay when recording the depreciation expense, such as when a piece of equipment has reached the end of its useful life. Every year, your business will convert part of the total cost invested and its fixed assets into cash. You’ll recover this amount through cash collections from sales so depreciation is a positive cash flow factor.

Credit Terms

Your credit terms are the time limits you set for your customer’s promise to pay for what they purchased from you. Your credit terms affect the timing of how often you receive revenue. Offering trade discounts is one way to improve cash flow. Giving your customers discounts for cash payments or cash transactions is a great way to boost your cash flow and keep things running smoothly.

Credit Policy

A credit policy is the guideline used when you decide whether or not to extend credit to a customer. A correct credit policy is crucial to ensuring that your cash flow doesn’t suffer because it is too strict or too generous.

By understanding the factors that influence changes in cash flow, you can build a strategy that keeps you in the black.

A Closer Look at Accounts Receivable and Cash Flow

Accounts receivable record sales that you have not yet collected revenue from. You sell goods or services in exchange for a customer’s promise to pay you within a certain time frame in the future. If your organization typically extends credit to customers, then the payment for accounts receivable is most likely the main source of cash.

Worst case, unpaid accounts receivable leave your business without the cash flow you need to pay your own bills. More commonly, slow-paying or late-paying customers create cash shortages which leave your business without the necessary cash flow to cover your outflow obligations.

Accounts receivable also represent Investments. Money in accounts receivable isn’t available to pay back loans, pay bills, or expand your business. The payoff from the investment in accounts receivable won’t occur until your customer pays, which influences the amount of cash you have on hand and the liquidity of your business. It’s important to understand the concept of accounts receivable as an investment if you want to consider its impact on your cash flow and free cash balance.

Use the following financial ratios to determine how your accounts receivable are impacting your cash inflows:

Average collection period
Accounts receivable to sales ratio
Accounts receivable aging schedule

Average Collection Period

Your average collection period is the amount of time it takes to convert your average sales into cash. Using this measurement, you can define the relationship between accounts receivable and cash flow for any period of time. If you have a longer average collection period, you’ll have a higher investment in your accounts receivable. It also means there’s less cash available to cover your expenses when other cash outflows.

Calculate your average collection period by dividing your annual sales by 360. you can use the annual sales amount and accounts receivable balance from the prior year as it is typically accurate enough to analyze and manage your cash flow. But if more recent information is available use that instead. Calculate the average daily sales correctly by using the number of days reflected in the sales figure. If you used data from the last quarter, divide the total by 90 rather than 360.

For instance, Sandra owns and operates a crafting business. Sandra’s total annual sales from the previous year were $50,000. The total balance of his accounts receivable at the end of the same year was $3,000. Sandra’s average collection period is calculated like this.

$50,000/360 = $138.89 average daily sales volume
$3,000/138.89 = 21.6 (rounded up to the nearest whole number for total days) = 22 days average collection period.

For Sandra’s previous year, each dollar of sales was invested in accounts receivable for 22 days. Assuming that her business hasn’t changed drastically from the last year, cash flows from sales on account won’t be available for use for 22 days.

Accounts Receivable to Sales Ratio

The accounts receivable to sales ratio is a metric that measures the rate at which your business is selling its invoices to customers. This ratio gives you an idea of how quickly your company converts invoice sales into cash in hand, and it can also give you insight into what might be slowing down that process. The higher the ratio, the faster your business converts its invoices into cash in hand, which can mean that you can rely on sales from invoices even if you’re not getting paid immediately by customers.

The ratio looks that your accounts receivable investment and how it relates to your monthly fails amount. It helps you to spot recent increases in your accounts receivable. With monthly sales information, this ratio serves as a quick and easy way to look at changes in accounts receivable. The more recent information you use, the easier it will be to find cash flow problems.

Calculate your accounts receivable to sales ratio by dividing your accounts receivable balance at the end of the month by your total sales for the month.

For example, Sandra’s accounts receivable balance at the end of the month was $2,000 and the total sales from the same month were $4,000. Sandra’s accounts receivable to sales ratio is 2.

Accounts Receivable Aging Schedule

The aging schedule is a table where each row shows daily credit sales, debits, and days of credit terms. The aging schedule provides an at-a-glance snapshot of which invoices are overdue, as well as how much money you’re owed. Aging schedules are an important accounting tool that shows how quickly your accounts receivable turn over.

When comparing two different businesses, a business with shorter accounts receivable aging schedule would have faster cash flow than a business with a longer accounts receivable aging schedule. Keep in mind that it’s not just about days past due; accounts receivable turnover measures both your outstanding debt balance and how fast you collect on your invoices.

Final Thoughts

Cash flow from operations is a crucial metric that tells you how much cash your organization is generating from business activities. Much of its function comes from the income statement and the balance sheet statement including net income and working capital. Any change in the factors that make up the line items such as inventory, accounts receivable, accounts payable, sales and costs, can all influence cash flow from operations.

Your net cash flow is a key indicator of your company’s financial health. While it’s okay for financing activities and investing activities to periodically and temporarily put you in a negative cash flow, you must operate with a positive cash flow overall.

When your business is spending more than it’s bringing in, you run a negative cash flow. In other words, your sales are not enough to cover your expenses. If it continues indefinitely, you risk going out of business because you won’t be able to pay your bills.

Download PDF

What’s your goal today?

1. Use Planergy to manage purchasing and accounts payable

Read our case studies, client success stories, and testimonials.
Visit our “Solutions” page to see the areas of your business we can help improve to see if we’re a good fit for each other.
Learn about us, and our long history of helping companies just like yours.

2. Download our guide “Preparing Your AP Department For The Future”

Download a free copy of our guide to future proofing your accounts payable department. You’ll also be subscribed to our and notified about new articles or if have something interesting to share.

3. Learn best practices for purchasing, finance, and more

Browse hundreds of articles, containing an amazing number of useful tools, techniques, and best practices. Many readers tell us they would have paid consultants for the advice in these articles.

The post How To Avoid A Decrease In Cash Flow From An Increase In Operations appeared first on Planergy Software.

Segregation Of Duties In Accounts Payable

Mary Girsch-Bock — Thu, 09 Jun 2022 16:06:47 +0000

Download a free copy of "Preparing Your AP Department For The Future", to learn:

How to transition from paper and excel to eInvoicing.
How AP can improve relationships with your key suppliers.
How to capture early payment discounts and avoid late payment penalties.
How better management in AP can give you better flexibility for cash flow management.

Download Free Copy

Segregation Of Duties In Accounts Payable

Category

Accounts Payable

Written by Mary Girsch-Bock
17 min read

Tags

Best Practices & Tips Governance Risk Management & Compliance (GRC)Invoice Processing

Last edited

December 15, 2023

Download PDF

Why Segregation of Duties is Important in Accounts Payable

Segregation of duties is important in both accounts receivable and accounts payable. Also known as separation of duties, using these internal controls helps to mitigate potential errors, reduce the occurrence of fraud, and ensure accuracy. It’s never a good idea to have one person in charge of any accounting process, and accounts payable is no exception.

Managing accounts payable properly is important for numerous reasons. Processing invoices promptly, and paying them when due helps companies build a strong relationship with vendors. On the other hand, late or inaccurate payments can quickly destroy a vendor/business relationship.

Another reason why managing accounts payable properly is so important is because of the potential for payment fraud. It’s well known that accounts payable is particularly prone to fraud if proper guidelines are not followed.

That’s why segregation of duties is vital for any business. Whether you have a small business or a global organization, segregation of duties is a necessity.

What does segregation of duties mean?

Segregation of duties is an internal control process that all businesses should implement if possible. While the one-person office is likely the sole processor of all accounting transactions, even a two-person office should implement some form of segregation of duties.

Used to reduce errors and mitigate fraudulent activity, segregation of duties simply means that more than one person should be involved in a particular process.

For example, in accounts payable, it’s recommended that one person be responsible for setting up vendors in the system, with one person responsible for entering invoices and running checks, with a third person responsible for signing those checks.

What are internal controls in accounts payable?

Accounts payable controls are put in place to safeguard the process from errors or fraud. These controls can help to mitigate a variety of risks, including payment errors, duplicate payments, late payments, and even fraudulent payments. These controls are usually broken down into three categories.

1. The obligation to pay

When you receive an invoice from a vendor, that creates an obligation to pay; provided that the following are verified:

Purchase order verification – A purchase order is typically used when purchasing products or services from a vendor. The purchase order should always be reviewed for accuracy before issuing a final order approval. The vendor should also be verified for legitimacy.
Invoice approval – The next step is verifying the invoice. This includes verification that the products or services were received as indicated in the purchase order and that the amount of the invoice is accurate.
Document matching – The next step completed is the three-way match to ensure that the purchase order, invoice, and the receipt of goods reporting all match.
Look for duplicate payment – Prior to entering an invoice for payment, you should always verify that duplicate invoice numbers do not exist. Taking this extra step will eliminate costly duplicate payments.

2. Data entry

Once the invoice has been verified, you’re ready to move on to the data entry stage. Unfortunately, this is the stage where most of the potential errors are made. Depending on your internal accounts payable process, you can choose to enter an invoice into your accounting system immediately, and then obtain approval, or enter the invoice after it’s been approved.

A helpful process can be adding up the total of your invoices and then reviewing accounts payable financial reporting totals to verify that they’re in balance.

3. Invoice payment

Whatever your internal payment process, invoice payment is an area where segregating duties is essential. For instance, one person can run checks, and another person can review and sign the checks. No single person should have the authority to run, review, and sign checks.

Potential issues can be reduced or eliminated by using procure-to-pay software, which we’ll talk about later in this article.

Having segregation of duties in place can reduce or even eliminate fraud. If you have one employee vetting vendors, entering invoices, paying those invoices, and writing checks, there’s no safeguard in place to prevent that employee from creating a fictitious vendor and writing a fraudulent check.

Which duties should be segregated?

The accounts payable process is the management and payment of the company’s short-term debt. While the accounts payable process often mistakenly starts with entering a vendor invoice, the accounts payable process starts much earlier, when a product or service is purchased.

While smaller businesses often skip the purchase order process, mid-sized to larger businesses typically have a purchasing department in charge of locating and vetting vendors and placing orders. Larger businesses may also have a receiving department that verifies that the order received matches the original purchase order.
Once this process is complete, an invoice is received by the AP department, where It then becomes the job of accounts payable to verify all of the information on the invoice, such as the number of products ordered, verifying that the information on the invoice matches the purchase order as well as the receiving report, if available.
Next, the invoice information is entered into your software application for the amount indicated on the invoice, with the due date specified.
When the due date is close, a check or electronic payment is processed.

All of these duties should be segregated. In other words, the person purchasing the products or services should not be the same person that enters the invoice, nor the person who signs the checks. At minimum, the following duties should be assigned to at least three employees.

Purchasing products– In larger businesses with a purchasing department, this is standard practice, but for smaller companies with fewer employees, purchasing and approvals should always be separate.
Confirmation of receipt of products – The employee who places the order should not be the same employee who confirms receipt of the order.
Reviewing an invoice – Reviewing and approving an invoice should be completed before the invoice is entered into the system to be paid. This process also includes vetting vendors if not done by the purchasing department.
Entering an invoice – entering an invoice can be done by a clerk, provided that they have not initiated the purchase in any way.
Paying an invoice – Paying an invoice either electronically via ACH or by check should be completed by a separate employee.
Signing the checks – If you still process checks for your vendors, the check run should be completed by one employee, with another employee signing the checks.

An example of segregation of duties

Jim runs a small business, with five staff members, including two clerks in the accounting department, with Jim approving all new vendors. When he receives an invoice, he verifies that the goods have been delivered as indicated on the invoice, or the services received. He approves the invoice and routes it to his accounting clerk, who entered it into their accounting software application.

The second accounting clerk reviews the accounts payable report against the invoices, spotting and correcting any errors. When it’s time to pay the vendors, the second clerk is told which invoices should be paid. Once checks are processed, or electronic payments prepared, Jim approves the payments and signs the checks.

While this is a simplified version of segregation of duties, the main takeaway is that the person who initiates payment or completes the check run should not be the same person who approves electronic payment or signs the checks.

What are the benefits of segregating duties?

Spreading accounts payable tasks between multiple employees offers multiple benefits. It helps to reduce error occurrence since more than one person is involved in the process from beginning to end. Having a second set of eyes can help catch errors quicker than relying on one person to review, enter, and check all accounts payable transactions.

But even more important, from an audit standpoint, having segregation of duties in place can reduce or even eliminate fraud. For example, if you have one employee vetting vendors, entering invoices, paying those invoices, and writing checks, there’s no safeguard in place to prevent that same employee from creating a fictitious vendor and writing a fraudulent check.

What are the disadvantages of segregation of duties?

For smaller businesses, the need to add an additional employee to truly segregate duties may be the only disadvantage. In the end, choosing not to segregate duties puts your business at high risk for errors and fraudulent activity.

What is the difference between segregation of duties and a sign-off?

A sign-off is used more often in smaller businesses, where complete segregation of duties may not be possible. For example, Sara is the only accounting clerk for a small business. Linda, the owner of the business approves vendors and invoices, then gives them to Sara to enter. When invoices are due, Sara runs a report, which Linda signs off on to determine which bills should be paid. After entering payment information electronically or after running checks, Linda then approves the electronic payments, or signs the checks that Sara has run.

What is the relationship between the segregation of duties and the principle of least privilege?

Though similar in scope, there are some differences between segregation of duties and the principle of least privilege. The principle of least privilege states that computer users should be provided with the least amount of access to perform their job duties. On a related note, segregation of duties indicates that employees should not be authorized to complete an accounting function on their own. Using the segregation of duties principle when setting up access to your accounting or procurement software application will provide staff members with the ability to perform the tasks related to their job and nothing more.

How does procure-to-pay software help with internal controls?

Purchasing is a big part of the accounts payable process, which is why utilizing a procure-to-pay application such as Planergy can be helpful. Procure-to-pay software offers complete automation of the entire purchasing and accounts payable process, from initial order to vendor payment, all while enforcing internal controls. Using procure-to-pay software, you can manage your vendors, create workflow solutions, view purchasing activities at any time, and automate the invoice approval process. You can also process accounts payable disbursements while reducing errors and eliminating the possibility of fraud.

Whether you’re using a small business accounting application or an ERP system, you can benefit from using procure-to-pay software.

Segregation of duties is part of the accounting process

The appropriate segregation of duties should be part of your internal controls. While challenging for smaller businesses, more than one person should always handle the following if possible:

Initiating a transaction – this includes creating an initial requisition or purchasing an item or service.
Approving a transaction – if you initiated the transaction, another employee should approve it for payment.
Entering or recording transactions – this includes recording the transaction or setting it up for payment.
Processing a payment transaction – this includes preparing an invoice for payment or completing a check run.
Approving payment or signing a check – an employee that prepares electronic payments or other expenditures should not approve payments or sign checks. This includes any petty cash transactions.
Handling the bank reconciliation – anyone entering or recording a transaction, or approving a transaction should not be a signer on the bank account or handle the bank reconciliation process.

These preventative measures will reduce errors, ensure payments are made accurately and on time, and help to eliminate fraud. If you’re not segregating duties in your business, you should implement the process today.

Download PDF

What’s your goal today?

1. Use Planergy to manage purchasing and accounts payable

Read our case studies, client success stories, and testimonials.
Visit our “Solutions” page to see the areas of your business we can help improve to see if we’re a good fit for each other.
Learn about us, and our long history of helping companies just like yours.

2. Download our guide “Preparing Your AP Department For The Future”

Download a free copy of our guide to future proofing your accounts payable department. You’ll also be subscribed to our and notified about new articles or if have something interesting to share.

3. Learn best practices for purchasing, finance, and more

Browse hundreds of articles, containing an amazing number of useful tools, techniques, and best practices. Many readers tell us they would have paid consultants for the advice in these articles.

The post Segregation Of Duties In Accounts Payable appeared first on Planergy Software.

How To Use Activity Ratio Analysis To Understand Business Efficiency

Mary Girsch-Bock — Wed, 02 Feb 2022 16:48:12 +0000

Download a free copy of "Preparing Your AP Department For The Future", to learn:

How to transition from paper and excel to eInvoicing.
How AP can improve relationships with your key suppliers.
How to capture early payment discounts and avoid late payment penalties.
How better management in AP can give you better flexibility for cash flow management.

Download Free Copy

How To Use Activity Ratio Analysis To Understand Business Efficiency

Category

Finance

Written by Mary Girsch-Bock
20 min read

Tags

Financial Planning & Analysis (FP&A)Financial Ratios Governance Risk Management & Compliance (GRC)

Last edited

June 24, 2024

Download PDF

Activity Ratio Analysis & Why It’s Important

Activity ratios, commonly known as efficiency ratios are designed to measure business efficiency.

When used with other financial ratios such as the profitability ratio and liquidity ratio, activity ratios measure company performance, allowing business owners to see how well they’re managing their assets, and whether those assets are being used to generate income.

The numbers used to calculate activity ratios are easily found on a balance sheet.

While reviewing a balance sheet can help with initial analysis, calculating the ratio can provide additional information and help track trends over an extended period easier than simple financial statement analysis.

Generally speaking, activity ratios use operating activities and expenses. Non-operating or one-time expenses such as relocation expenses or the sale of an asset are typically not included when calculating activity ratios.

Like any financial ratio, activity ratios must be properly analyzed once calculated. And like most ratios, those results should be tracked over time for better trend analysis.

7 major types of activity ratios

There is a long list of activity ratios that business owners can calculate. We’ve picked out seven of the most commonly used ratios; explaining what each ratio is used for, the formula for calculating the ratio, and what the results mean.

While most activity ratios are calculated annually, you can also calculate them more frequently if you wish.

The numbers used for calculating these ratios can be obtained from your balance sheet or income statement.

1. Accounts payable turnover ratio

The accounts payable turnover ratio provides a good look at how quickly your company can pay off its debts by looking at the number of days between vendor and supplier purchases and when payment is made.

The number of days used in this calculation can vary, depending on the frequency the ratio is calculated.

For those calculating the accounts payable turnover ratio quarterly, the number of days used is 90, while a full year is 365 days.

The formula for calculating the accounts payable turnover ratio is as follows:

Total Purchases / Average Accounts Payable = Accounts Payable Turnover Ratio

To properly calculate this ratio, you’ll need to obtain the amount of purchases your company has made on credit for the time frame that you’re calculating the ratio for.

If you’re calculating the accounts payable turnover ratio for the year, you’ll need to have the total amount of credit purchases made for the year.

Next, you’ll need to run a balance sheet for the beginning of the year and the end of the year to obtain beginning and ending accounts payable balances, you’ll need to average.

For example, let’s say that you made $925,000 in credit purchases for the year.

Your beginning accounts payable balance for 2021 was $175,000 while your ending balance was $225,000, making your average accounts payable balance $200,000 for 2021. Now you can calculate your accounts payable turnover ratio.

$925,000 / $200,000 = 4.6%

A 4.6% ratio indicates that your accounts payable balance has turned over four and a half times during the year.

A higher ratio is more favorable to investors and creditors, while a lower number can indicate slower payment, making your company more of a risk.

The trick is to keep this number somewhere in the middle, as you don’t want to pay your bills too quickly, but you also don’t want to pay them late either.

Like any financial ratio, activity ratios must be properly analyzed once calculated. And like most ratios, those results should be tracked over time for better trend analysis.

2. Accounts receivable turnover ratio

Like the accounts payable turnover ratio, the accounts receivable turnover ratio measures how quickly your customers pay their credit accounts.

To calculate this ratio, you’ll need to obtain your credit sales totals for the timeframe in question, making sure that any cash sales or unrelated revenue are subtracted from the sales total.

You’ll also have to calculate your average accounts receivable balance as well.

Net Credit sales / Average Accounts Receivable = Accounts Receivable Turnover Ratio

For example, let’s say that your credit sales for the year were $1.2 million for 2021 while your beginning accounts receivable balance was $124,000 and your ending balance was $112,000, making your average accounts receivable balance $118,000.

$1,200,000 / $118,000 = 10.17

This means that your accounts receivable balance has turned over approximately 10 times during the year.

A higher number indicates that your credit customers are paying you promptly, while a lower number indicates slower payment or poor credit or collection policies that may need to be reviewed.

3. Average collection period ratio

If you want to see exactly how many days it’s taking to collect your accounts receivable balances, the average collection period ratio can help.

While the accounts receivable turnover ratio summarizes collection activity, it doesn’t provide the specificity that the average collection period ratio can.

Days in Period x Average Accounts Receivable / Net Sales = Average Collection Period Ratio

If you’re calculating this ratio annually, you’ll want to use 365 days in the period.

You’ll also need to obtain your average accounts receivable balance as you did for the accounts receivable turnover ratio, with net credit sales obtained from your balance sheet.

Using the average accounts receivable balance and net credit sales from above, let’s calculate the average collection period ratio.

365 x $118,000 / $1,200,000 = 35.9%

This result shows that it takes your company an average of 36 days to collect payment on an invoice.

The lower the ratio result, the faster you’re collecting on accounts receivable balances. How this ratio result is interpreted depends on the credit terms your customers are offered.

For instance, if your credit customers are typically offered NET 30 terms, they’re paying slightly late, while if your typical credit terms are NET 45, your customers are paying you ten days early.

4. Fixed asset turnover ratio

The fixed asset turnover ratio measures the ability of your business to generate sales from your fixed assets.

Net Sales / Average Fixed Assets = Fixed Asset Turnover Ratio

To calculate this ratio, you’ll need to first find your average fixed assets total, which you can obtain from a beginning and ending balance sheet for the period in question.

Next, you’ll find your net sales total. Be sure to include both credit and cash sales in your total, and subtract any returns and allowances.

For this example, let’s say that your Net Sales for the year are $1,375,000, with a beginning fixed assets total of $82,000 and an ending balance of $90,000, making your average fixed assets balance $86,000.

$1,375,000 / $86,000 = 16%

This result indicates that for every dollar in fixed assets that your business carries, you are currently earning $16.

While a higher fixed asset turnover ratio is considered desirable, too low of a result can indicate inadequate sales coupled with improper utilization of your fixed assets.

5. Inventory turnover ratio

If you own a retail business, knowing your inventory turnover ratio is essential. The inventory turnover ratio is a metric that measures how efficient your current inventory management is.

Cost of Goods Sold / Average Inventory = Inventory Turnover Ratio

To calculate the inventory turnover ratio, you’ll need two sets of numbers: your cost of goods sold for the period you’re calculating the ratio for, and your average inventory totals for that same period.

Your average inventory total can be obtained from beginning and ending balance sheets for that period, while your cost of goods sold can be found on your income statement.

For this example, let’s say that your beginning inventory for 2021 is $55,000, with an ending inventory of $54,000, while your cost of goods sold for 2021 totals $ $550,000.

$550,000 / 54,500 = 10.09%

The results above indicate that your inventory turnover for 2021 was 10%, meaning that inventory levels turned over ten times during the year.

A good inventory turnover ratio is between 5-10, with a low ratio of less than 5 indicating poor product demand or weak sales, while a high ratio (over 5) indicates strong sales.

Some retailers will calculate the inventory turnover ratio inclusive of all products, or calculate the ratio on one particular line of merchandise to better measure product demand.

6. Total asset turnover ratio

Similar to the fixed asset turnover ratio, the total asset turnover ratio calculation includes all company assets and is used to measure your company’s ability to use its assets to generate sales.

Net Sales / Average Total Assets = Total Asset Turnover Ratio

Designed to be calculated at year-end, the total asset turnover ratio results can vary widely from industry to industry, so when comparing your results, be sure to compare them to like companies.

Based on the information used earlier, we already know that net sales for 2021 are $1,375,000.

Your beginning asset total on your balance sheet for 2021 was $100,000, with an ending balance sheet total of $98,000, making your total average assets for 2021 $99,000.

$1,375,000 / $199,000 = 6.9%

A ratio of 6.9% indicates that for each dollar of assets your company has, you’re currently able to generate $6.90 in sales.

A result less than 1 indicates that assets are not being used properly, while a higher number indicates that assets are being used to generate income.

7. Working capital ratio

The final activity ratio we’ll look at is the working capital ratio. The working capital ratio looks at how efficiently your business currently uses your working capital.

Net Sales / Working Capital = Working Capital Ratio

Your working capital is a simple calculation – current assets minus current liabilities.

For the year ending 2021, your current assets are $113,000, while your current liabilities are $85,000, which makes your working capital $48,000. We already know that net sales are $1,375.000.

$1,375,000 / $48,000 = 28.6%

The result means that for every $1 of liabilities, you have more than $28 in assets.

A high working capital ratio indicates that your business is using both short-term assets and liabilities to generate sales, while a lower working capital ratio can indicate bad debt or sluggish inventory movement.

A good working capital ratio varies from industry to industry, so be sure to only compare your results to similar businesses but there is always room to improve your working capital and liquidity.

Limitations and disadvantages of activity ratios

While a valuable reporting tool, financial ratios such as activity ratios only provide a portion of the information you need in determining how efficient your business is currently operating.

And like accounting ratios in general, activity ratios only look at historic activity, which can provide you with details on how your business has been performing to a certain point but is incapable of predicting future performance.

In addition, Activity ratios, like all accounting ratios, provide valuable information but do nothing to resolve any current financial issues.

And if used out of context, the information they provide may be misleading.

Finally, if your financial statements are inaccurate, the ratios will be as well, so be sure to start with accurate financial statements.

Using activity ratios in your business

When used properly, activity ratios can tell you everything from how quickly you’re moving inventory to how fast you’re paying your suppliers.

They also provide valuable metrics for your business, showing you where your business is thriving while helping to pinpoint problem areas.

For example, if you find that your accounts receivable turnover ratio is too low, taking steps such as reassessing your credit terms and who is eligible for credit can go a long way towards improving your ratio results.

If you choose to use activity ratios in your business, you must do so consistently.

Running a ratio once will tell you little about business performance, but running these ratios consistently will allow you to observe trends and address any issues as they arise.

And when analyzing your ratio results, be sure to compare them with businesses in the same industry.

Running a profitable business is not easy.

Having the tools necessary to facilitate growth and profitability can go a long way towards making your business sustainable in the near term and for years to come.

Using tools such as activity ratios will make that task just a little bit easier.

Download PDF

What’s your goal today?

1. Use Planergy to manage purchasing and accounts payable

Read our case studies, client success stories, and testimonials.
Visit our “Solutions” page to see the areas of your business we can help improve to see if we’re a good fit for each other.
Learn about us, and our long history of helping companies just like yours.

2. Download our guide “Preparing Your AP Department For The Future”

Download a free copy of our guide to future proofing your accounts payable department. You’ll also be subscribed to our and notified about new articles or if have something interesting to share.

3. Learn best practices for purchasing, finance, and more

Browse hundreds of articles, containing an amazing number of useful tools, techniques, and best practices. Many readers tell us they would have paid consultants for the advice in these articles.

The post How To Use Activity Ratio Analysis To Understand Business Efficiency appeared first on Planergy Software.

How To Use Solvency Ratio Analysis For Your Business

Mary Girsch-Bock — Mon, 31 Jan 2022 16:49:49 +0000

Download a free copy of "Preparing Your AP Department For The Future", to learn:

How to transition from paper and excel to eInvoicing.
How AP can improve relationships with your key suppliers.
How to capture early payment discounts and avoid late payment penalties.
How better management in AP can give you better flexibility for cash flow management.

Download Free Copy

How To Use Solvency Ratio Analysis For Your Business

Category

Finance

Written by Mary Girsch-Bock
16 min read

Tags

Financial Planning & Analysis (FP&A)Financial Ratios Governance Risk Management & Compliance (GRC)

Last edited

June 24, 2024

Download PDF

Solvency ratios are designed to measure the overall profitability of a business by comparing profitability levels against current financial obligations.

Calculating and analyzing these ratios can provide business owners, CFOs, investors, and banking institutions with valuable financial insights including the company’s ability to meet its current long-term debt obligations.

Calculating the company’s solvency ratios is just as important for small businesses as it is for larger ones.

But calculating a ratio is only the first step. Equally important is solvency ratio analysis, which examines ratio metrics and builds a more complete picture for management, investors, creditors, and lenders to review.

What is Solvency?

The concept of solvency is quite simple. As a business owner, you always want more assets than liabilities. To be considered solvent, a business should be able to pay their bills both short term and long term.

In many cases, the solvency of a business can be easily assessed by reviewing the business balance sheet and cash flow statement.

However, investors, creditors, and analysts often turn to solvency ratios to better determine solvency.

Solvency ratios also help business owners and CFOs keep an eye on company trends, particularly if debt continues to increase without a concurrent increase in revenue or assets.

Common Solvency Ratios

There are numerous types of solvency ratios that can be calculated to determine company solvency, with four used most frequently.

Debt to asset ratio
Debt to equity ratio
Equity ratio
Interest coverage ratio

Each of these solvency ratios measures the solvency (or insolvency) of a different portion of your company.

Staying on top of issues such as liquidity and solvency can help you be more proactive in managing your company’s financial health; addressing red flags as they occur, not months, or even years down the road.

Solvency vs. Liquidity: What’s the Difference?

Though often confused with liquidity, solvency addresses the long-term financial health of your business, while liquidity focuses on how quickly a business can convert current assets into cash.

Not only does solvency look at whether your business can meet current financial obligations, but it also examines whether your business can meet long-term obligations well into the future.

Though it’s possible to have low liquidity but remain solvent, it’s best if your business is both liquid and solvent.

How to calculate your small business’ solvency

To be solvent, you must own more than you owe.

While reviewing financial statements is a good start in determining solvency, there are numerous solvency ratios that you can calculate to determine how solvent your business is.

Debt–to-asset ratio: If you only run one solvency ratio, it should be the debt-to-asset ratio.

This ratio measures the percentage of assets that are currently financed with both short-term debt and long-term liabilities.

A higher number means higher leverage, and more financial risk, while a low ratio indicates stability.

The formula to calculate your debt-to-asset ratio is as follows:

Total Liabilities / Total Assets = Debt-to-Asset Ratio

For example, for the fiscal year 2020, Sky Manufacturing had total assets of $7 million and total liabilities in the amount of $4.5 million on its balance sheet. To calculate Sky’s debt-to-asset ratio you would perform the following calculation:

$4,500,000 / $7,000,000 = 0.64

This result indicates that almost 65% of Sky Manufacturing’s assets are funded by debt. While not in the danger zone, many financial experts recommend a total debt-to-asset ratio of 0.5 or less for the best financial stability.

Debt-to-equity ratio: If you’re concerned about the amount of outstanding debt you’re financing compared to your total equity, the debt-to-equity ratio can be helpful.

The debt-to-equity ratio can vary widely from industry to industry, so it’s best to compare your results to similar companies.

To calculate the debt-to-equity ratio, just locate your total liabilities and your total shareholder’s equity on your current balance sheet. The formula to calculate the ratio is as follows:

Total Liabilities / Total Shareholder’s Equity = Total Debt-to-Equity

We already know that Sky Manufacturing’s liabilities total $4.5 million, with assets of $7 million, so their equity would be $2.5 million. We can calculate the debt-to-equity ratio as follows:

$4,500,000 / $2,500,000 = 1.8

This result indicates that for every $1 of equity, Sky Manufacturing is currently carrying nearly $2 in company debt.

A good debt-to-equity ratio is less than 1, while a ratio of 2 or higher indicates higher risk. Like most ratios, it’s best to compare your results with those in your industry.

Equity Ratio: If you’re concerned about being over-leveraged, one of the best ratios to calculate would be the equity ratio. A leverage ratio, the equity ratio gives you a quick summary of how much debt you’re currently carrying relative to current assets.

The formula for calculating the equity ratio is:

Total Equity / Total Assets = Equity Ratio

Using Sky Manufacturing’s numbers from above, let’s calculate total equity.

$2,500,000 / $7,000,000 = 0.36 or 36%

This result means that investors are funding only 36% of the company’s assets, with creditors funding the balance.

A good equity ratio is usually 50%, with anything below 50% considered leveraged, meaning that Sky finances more assets using debt rather than equity. A higher ratio means that assets are funded with equity.

Interest Coverage Ratio: The interest coverage ratio centers on one specific area of your business: it measures how well you can meet the interest expense on any debt your business is currently carrying.

While not every business will need to run the interest coverage ratio, it can be helpful for businesses that carry a lot of debt.

To calculate the interest coverage ratio, you’ll first have to obtain your operating earnings, which are earnings before interest and income taxes, commonly abbreviated as EBIT. You can get your company’s EBIT total from the income statement.

To calculate the interest coverage ratio, use the following formula:

EBIT / Interest Expense = interest coverage ratio

We’ll say that Sky Manufacturing had an EBIT of $1.4 million and interest expenses of $940,000.

$1,400,000 / $940,000 = 1.49

In general terms, an interest coverage ratio should be at least 2. Anything lower can signal that a business may be unable to cover all of its debt in the future.

In addition to these common solvency ratios, you may find the current ratio and the quick ratio useful. The current ratio compares current assets to current liabilities, while the quick ratio measures short-term obligations using only liquid assets.

What Do the Results Mean?

Solvency ratios can help you assess company solvency, but won’t provide you with all the information you need to make an informed assessment.

For example, while the ratio results will point out how much of your assets have been financed using debt, they don’t provide necessary details such as what those assets are and what they’re used for.

Using Sky Manufacturing as an example, let’s start with their debt-to-asset ratio of 0.64. While not a red flag, this result indicates that nearly two-thirds of Sky Manufacturing’s assets are funded by debt, rather than by equity.

If this ratio increases, it can put the company in the danger zone, and send a message to investors and financial institutions that the business is not sustainable.

Next, let’s look at their debt-to-equity ratio of 1.8. Since industry standards can vary, it would help to compare this result to similar manufacturing companies.

Since most industry experts suggest a debt-to-equity ratio of 1 or less and place a 2 in the danger zone, Sky Manufacturing is in the middle with a 1.8 result. If this does not increase, they will likely remain a good option for investors and a safe bet for lenders.

Sky’s equity ratio results came in at 36%, meaning the company is leveraged.

A higher ratio of more than 50% is viewed by investors and lenders as conservative; meaning that it uses more debt to acquire assets. But financial leverage is not always a bad thing, particularly for newer companies.

However, if Sky Manufacturing could raise the level closer to 50%, they would be more attractive to investors.

Finally, Sky’s interest coverage ratio is 1.49. This result indicates that the company can pay its current interest payments about one and a half times.

Most industry experts prefer to see a 2 but are not overly concerned unless the interest coverage ratio drops to 1 or below.

Analyzing these ratio results together, it looks like Sky Manufacturing is operating adequately, with some room for improvement, including working to increase their net income while decreasing the amount of debt on the books.

Using solvency ratios and analysis properly

When calculating solvency ratios, you must do the following:

Analyze results: While calculating the ratio is an important first step, it serves no purpose if those results are not properly analyzed.
Track results long term: If you run solvency ratios once, they serve no purpose. Instead, be sure to calculate them regularly, paying close attention to trends. A good solvency ratio today may be trending downward, while a poor result may trend upward. Only by paying attention to these trends can you make informed decisions about your company.
Always compare results to similar companies: If you have a computer repair business, you don’t want to compare your solvency ratio results with those of a manufacturing company. Always compare results within your industry.

Staying on top of issues such as liquidity and solvency can help you be more proactive in managing your company’s financial health; addressing red flags as they occur, not months, or even years down the road.

When used with other financial ratios such as liquidity ratios, the capital ratio, or the quick ratio, solvency ratios can help you be better prepared for the future and ward off potential issues before they occur.

Download PDF

What’s your goal today?

1. Use Planergy to manage purchasing and accounts payable

Read our case studies, client success stories, and testimonials.
Visit our “Solutions” page to see the areas of your business we can help improve to see if we’re a good fit for each other.
Learn about us, and our long history of helping companies just like yours.

2. Download our guide “Preparing Your AP Department For The Future”

Download a free copy of our guide to future proofing your accounts payable department. You’ll also be subscribed to our and notified about new articles or if have something interesting to share.

3. Learn best practices for purchasing, finance, and more

Browse hundreds of articles, containing an amazing number of useful tools, techniques, and best practices. Many readers tell us they would have paid consultants for the advice in these articles.

The post How To Use Solvency Ratio Analysis For Your Business appeared first on Planergy Software.

Governance Risk Management & Compliance (GRC) Archives : Planergy Software

Vendor Analysis: What Is It, Process, Types, and Best Practices

What's Planergy?

Cristian Maradiaga

King Ocean

Download a free copy of "Indirect Spend Guide", to learn:

Vendor Analysis: What Is It, Process, Types, and Best Practices

KEY TAKEAWAYS

What is Vendor Analysis?

What is a Vendor Analysis Report?

What Does a Vendor Analyst Do?

What Is Vendor Due Diligence?

Vendor Analysis vs. Vendor Assessment

The Vendor Analysis Process

Selection Criteria

Pre-Screening

Questionnaire

Site Visit

Negotiation

Different Types of Supplier Analysis

Cost-Based Analysis

Capabilities-Based Analysis

Performance-Based Analysis

Strategic Analysis

Vendor Risk Analysis

Best Practices for Effective Vendor Analysis

Involve Key Stakeholders

Use a Vendor Management System to Track Everything

Choose Metrics to Evaluate All Suppliers Against

Leverage Vendor Scorecards to Compare Results

Analyze Your Current Suppliers – Not Just New Ones

Take Your Time – Do Not Rush Vendor Selection

Vendor Performance and Evaluation Can Make or Break Your Business

What’s your goal today?

1. Use Planergy to manage purchasing and accounts payable

2. Download our “Indirect Spend Guide”

3. Learn best practices for purchasing, finance, and more

Related Posts

Accounts Payable Policy: What Is It, Best Practices, and an Example Template

What's Planergy?

Cristian Maradiaga

King Ocean

Download a free copy of "Preparing Your AP Department For The Future", to learn:

Accounts Payable Policy: What Is It, Best Practices, and an Example Template

IN THIS ARTICLE

What Is an Accounts Payable Policy?

What Are the Functions of Accounts Payable?

What Is the Typical AP Process?

What Are Internal Controls for Accounts Payable?

Obligation to Pay

Data Entry

Invoice Payment

Fraud Controls

What Is an Accounts Payable Write-Off Policy?

Cancellation of Liability

Expiration of the Contract or Term

Best Practices for Creating an Effective Accounts Payable Policy & Procedures Manual

Fully Document Policies and Procedures

Share and Make Easily Accessible to Appropriate Staff

Review and Update Regularly

Accounts Payable Policy Template

Steps to Create an AP Policy and Procedure Manual

What Should be Included in Your Accounts Payable Policy and Procedures Manual

Department Overview

AP Responsibilities

Procurement Responsibilities

Approval Process for Purchase Orders

Approval Process for Invoices

Invoice Processing

Handling Disputed Invoices

Payment Policies

Early Payment Discount

Handling Lost and Uncashed Checks

Collecting and Managing Vendor Data

Record Retention Policy

Reconciliation

Accounts Payable Best Practices for Your Business

Simplify Workflows with AP Automation Software

Establish Internal Controls for Your Business

Strategically Manage Payments