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Ned Armstrong has been a member since July 27th 2014, and has created 58 posts from scratch.

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Effective Cash Systems – November 2017

This post involves Treasury. A critical duty of the CFO is to devise and operate a cash system. A well designed cash system is essential to effective cash management. A good cash system allows the CFO to anticipate cash needs and focus on working capital management – the key to an effective cash system. When determining working capital needs we recommend the use of the cash conversion cycle as the main management tool.
Using the cash conversion cycle lets the CFO know how many days must be funded with non-working capital sources such as bank credit lines. The measure is calculated as days in receivables plus days in inventory less days in payables. If the result of the calculation is, say, 80 days then the CFO will need to utilize all or part of the firm’s bank credit facility over that period.
Effective use of the bank line of credit will enable the CFO to provide operating cash, source emergency cash, minimize idle cash, invest excess cash, and control cash assets. The key means of achieving these goals entails accelerating collections and slowing disbursements. An important tool for doing so is the use of lock box operations and controlled disbursements.
Lock box operations entail a set up whereby payments are sent to a lock box at a bank rather than directly to the company. The bank retrieves and credits the account (via software) several times daily. The detail of what has occurred during the day is remitted to the company. The major benefit of lock box operations are that they eliminate internal float and post office processing, thereby making the cash collection effort quicker and more cost effective. That said, increased use of electronic payments has reduced, but not eliminated, this advantage particularly for small businesses that have customers who do not use advanced check writing technologies.
Controlled disbursements utilize a zero balance account whereby check clearing patterns are analyzed. Based on the analysis, a banking location is selected that will maximize the time required to clear checks. This location is driven by the company’s location, the bank network, and vendor location. While this methodology has been made quicker due to electronic banking, many small businesses can still use electronic check writing to create paper checks.
These strategies will help and be helped by the firm’s other efforts in cash management and liquidity management. Key functions in cash management include:
• Cash forecasting
• Working capital management
• Cash concentration
• Debt compliance
• Bank relations
Important liquidity management functions include:
• Cash reserve requirements
• Sufficient cash on hand for payment of bills
• Tracking Cash
• Compliance with contractually mandated cash balances
This post involves Treasury. A critical duty of the CFO is to devise and operate a cash system. A well designed cash system is essential to effective cash management. A good cash system allows the CFO to anticipate cash needs and focus on working capital management – the key to an effective cash system. When determining working capital needs we recommend the use of the cash conversion cycle as the main management tool.
Capitol CFO Solutions serves clients in Washington, D.C., Maryland, and Virginia. Please contact us for a free consultation.

Keeping Management in the Loop – October 2017

This post regards Financial Reporting. Projects are a necessary part of many business arrangements. A project can be defined as producing unique output rather than an ongoing stream of goods and services and has a definable starting point and ending point. Some examples of projects include R&D efforts, new buildings, an upgraded website, creating a new billing system, and a special order for a key client. We believe it is wise for the CFO to develop project specific billing, costing, and reporting systems.
When management decides to undertake a new project, the CFO or an employee is designated by the CFO to be the project accountant. This person is responsible for monitoring the progress of the project, investigating variances, ensuring the client is billed on a timely basis, and timely collection of amounts due on invoices issued. This responsibility consists of several specific tasks in the following areas:
• Records Management
• Expense Oversight
• Customer Billings
• Management Reporting
• Outside Party Reporting
Record management entails creating the appropriate accounts in a project-specific accounting system. In addition to assuring that correct entries are made, general records should be maintained. Such records include items like contracts, change orders, and documentation of expenses. The CFO or a designated representative is empowered to oversee access to project accounts and authorize expenses to the accounts. At the completion of the project, the CFO ensures that the project accounts are closed out and integrated into the firm’s general accounting records.
Expense oversight involves approval of all expenditures, time sheets, and overhead allocation related to the project. Moreover, the CFO should analyze and investigate reasons for variances relative to expectations and budgets. If necessary, corrective actions should be pursued. Finally, unpaid contract billings must be investigated and resolved.
Customer billings is a function that requires persistent oversight. Key tasks include creating or approving project related billings to customers; investigation of project costs not billed to customers; and the write off of billings to customers that are deemed unbillable or uncollectible.
Management reporting is crucial in keeping the CEO and other executives informed about the project’s progress. Executive management should be able to access information regarding the project’s profitability as well as an explanation of variances from financial and operational targets. In addition, management should be informed of opportunities to initiate additional bills to customers. Finally, it is critical that executive management be aware of the remaining funding available for the project.
In some instances, it may be necessary to report to outside parties on matters regarding a project. Such parties include independent Board members, customers, government entities, lenders, and auditors. It is up to the CFO to provide information that is both comprehensive and germane to the interests of such outside parties.
Projects are a necessary part of many business arrangements. A project can be defined as producing unique output rather than an ongoing stream of goods and services and has a definable starting point and ending point. Some examples of projects include R&D efforts, new buildings, an upgraded website, creating a new billing system, and a special order for a key client. We believe it is wise for the CFO to develop project specific billing, costing, and reporting systems.
Capitol CFO Solutions serves clients in Washington, D.C., Maryland, and Virginia. Please contact us for a free consultation

Plan Your Work and Work Your Plan– September 2017

This post involves strategy. The business plan translates the entrepreneur’s dream into a vision and expresses the pursuit of the vision through a mission statement. Positive execution of the mission statement is based on broad parameters of how the vision will be achieved over time. While the development of the business plan needs input from the CFO, it is far more than a document to achieve financing.
The CFO can contribute to an effective business plan in several ways. These include helping clarify the business concept; aid in SWOT analysis of competitors; formulating and assembling financial projections; and help avoid certain pitfalls encountered by many firms when they formulate a business plan.
When the CFO clarifies the business concept, we mean the CFO adds lucidity to the CEO’s vision. This effort entails an explanation of the products and services the business offers in terms that the average reader will understand. For example, rather than focus on scientific and engineering aspects of the business, the CFO may explain why the products are valuable to the customer. The CFO can also demonstrate the potential of the business model in ways that the reader can easily grasp. One instance may be to demonstrate growth potential by showing how steady increases in market share and/or pricing power over several years can drive sales and profit growth.
The CFO can contribute to a SWOT (Strengths, Weaknesses, Opportunities, and Threats) analysis of competitors in a number of ways. One is to identify the top 5 competitors, as well as competitors who may decide to enter the market at a later time. Another is to gather intelligence from suppliers, bankers, attorneys, and CPAs. The CFO can also scan competitor websites as well as internet message boards, Twitter, and Facebook. Moreover, the CFO can compile historical financial information regarding competitors. This can provide insights into benchmark development for the firm. Another way the CFO can be helpful is to get information on competitors from contacts at the firm’s customers. Finally, the CFO can describe the competition’s strengths and how they come to market.
A key responsibility for the CFO is to provide financial projections, including the underlying assumptions. Additional financial information the CFO should provide is breakeven analysis (units and dollar volumes); key financial ratios (liquidity, efficiency, profitability, capitalization); and financial strategy as it relates to funding, working capital management, and capital allocation priorities.
The CFO can be of great value in identifying pitfalls to avoid. This can be accomplished by:
1. Encouraging input from low level employees
2. Help employees understand how their current position relates to the business plan.
3. Avoid the temptation to use “hockey stick” projections, which are unrealistic and often dismissed by the readers of a business plan.

The business plan translates the entrepreneur’s dream into a vision and expresses the pursuit of the vision through a mission statement. Positive execution of the mission statement is based on broad parameters of how the vision will be achieved over time. While the development of the business plan needs input from the CFO, it is far more than a document to achieve financing. The CFO can contribute to an effective business plan in several ways. These include helping clarify the business concept; aid in SWOT analysis of competitors; formulating and assembling financial projections; and help avoid certain pitfalls encountered by many firms when they formulate a business plan.
Capitol CFO Solutions serves customers in Washington, D.C., Maryland, and Virginia. Please contact us for a free consultation.

Managing Accounts Receivable to Drive Performance – August 2017

This post involves Financial Management. The analysis of financial statements is often conducted by lenders and investors. Their purpose is to determine whether it is sensible to provide the company with funding. The CFO should also perform financial analysis, but with the goal to diagnose operating challenges, measure performance, and improve efficiency. The remainder of the post concerns a very large portion of the assets of many companies – Accounts Receivable (AR). This asset represents the amount owed to the company for products sold or services rendered.
We classify the areas of AR analysis into 4 categories:
• Inherent Profit Margin
• Age of the Trade Receivables
• Reliability of AR
• Amount of Bad Debt recognition
The interpretation of these characteristics of AR is one of the most important tools for the CFO to gauge the performance of the business. This includes insights gained into sales growth strategy, credit policy, collections funding, and the state of the economy. To gain these insights we suggest the CFO:
1. Measure the Contribution Margin
2. Measure the age of AR
3. Measure the Bad Debt percentage
4. Compare Bad Debt to AR
The Inherent Profit Margin is also known as the Contribution Margin which is sales less variable costs, expressed as a percentage of sales. Note that fixed costs do not play a role in this calculation. If the contribution margin is high, the firm will have a relatively small proportion of cash invested in each receivable as the cash costs to sales, and thus to AR, are relatively low. Accordingly, any bad debt can be more easily offset by large cash and the company has incurred relatively low cash outflows when the receivable is written off. This provides the firm with the flexibility to offer generous payment terms to drive sales growth.
On the other hand, a small contribution margin implies a bad receivable will have a greater negative impact on the firm’s cash balance, as relatively large cash outflows will not be covered by the collection of an invoice. As a result, the company will need to carefully extend credit and mount vigorous oversight on collection efforts.
The age of AR is expressed in terms of days and is calculated as AR divided by (Annual Sales divided by 365). The resulting figure is known as Days Sales Outstanding (DSO). Typically DSO is monitored quarterly and the resulting trend is tracked. A decline in DSO may indicate the presence of such factors as invoices written off, conversion of AR into cash, conversion of accounts into loans, tighter credit policy, collection of a substantial invoice, or a slowdown in business. An increase in DSO may indicate the presence of such factors as looser credit policy, unwillingness to write off overdue invoices, or product issues. These are good and bad factors, thus it is important that the CFO determine the reason for the trend in DSO and its magnitude so that the proper decision can be made regarding corrective action.
Reliability of doubtful accounts is an assessment of the adequacy of reserves held against AR. These reserves (known as Allowance for Doubtful Accounts) are an estimate of the expected bad debts contained within AR. When examining this item the CFO should consider several factors:
• New products or entry into new markets that may not have sufficient information on bad debts that will occur
• A large number of customers on which the firm has no history makes realistic estimates of bad debt very difficult
• Tightening credit policy will probably cause allowance to fall; loosening credit policy will probably cause allowance to rise
• The amount of bad debt realized will change along with economic conditions and management’s response. For example, if there is a recession and management has not restricted credit, one can reasonably expect bad debts to increase
• Estimates of Bad Debt to be incurred could be manipulated in hopes of larger profits and bonuses.
The CFO must aggressively monitor the allowance for doubtful accounts and take prompt action based on an evaluation of the factors above.
Bad Debt as a percentage of AR should be tracked over time, usually on a quarterly basis. The appropriate amount is determined by nature of the industry, internal policies we have discussed, economic conditions, and quality of personnel. Thus the CFO should investigate deviations from historical levels of this ratio and determine the cause. To do this effectively we recommend the adoption of a standard procedure for calculating the amount of the allowance for doubtful accounts and adhering to this procedure.
The analysis of financial statements is often conducted by lenders and investors. Their purpose is to determine whether it is sensible to provide the company with funding. The CFO should also perform financial analysis, but with the purpose of diagnosing operating challenges, measure performance, and improve. Accounts Receivable (AR) represents the amount owed to the company for products sold or services rendered. The interpretation of AR is one of the most important areas for the CFO to gauge the performance of the business. This includes insights gained into sales growth strategy, credit policy, collections funding, and the state of the economy.

Be Liquid and Profitable — July 2017

This topic involves Treasury. A key element of a firm’s liquidity and profitability is its working capital (current assets minus current liabilities). Converting accounts receivable and inventory to cash provides liquidity for paying creditors, investing in growth opportunities, and distributing cash to shareholders. The quicker this conversion occurs the greater the company’s return on invested capital, in our view the most important measure of the firm’s profitability. The CFO oversees several working capital functions that determine the company’s liquidity and profitability.
To provide the firm with sufficient liquidity while enhancing returns, the CFO must manage several tasks. These include: determine and execute the firm’s working capital strategy; optimize the cash conversion cycle; determine the appropriate short term investment vehicles; and manage the firm’s short borrowing efforts. Once these determinations are made the CFO must ensure that they are effectively executed. This can be challenging due to many tradeoffs that are extant in a company’s operations.
There are three working capital strategies the firm can pursue. The first, maturity matching, entails financing current assets with short term borrowing such as a bank line of credit. Long term assets such as equipment and vehicles are financed with long term borrowing such as bank term loans. Large projects, like new facilities, are financed with both long term financing and equity investments. We believe this is the most common working capital strategy.
A conservative working capital strategy utilizes long term debt to fund a portion of current assets. This strategy sacrifices potential profit increases for safety. An aggressive working capital strategy entails utilizing short term borrowing for a portion of the company’s long term assets. This strategy sacrifices safety for larger potential profit and is often pursued by banks and non-bank lenders as well as firms with an appetite for risk.
The cash conversion cycle is the amount of time the firm’s funds are tied up in working capital. The CFO’s goal is to reduce the cash conversion cycle without damaging supplier relationship, incurring stock outs, and losing sales. The cash conversion cycle consists of the purchase of inventory, payment for that inventory, sale of the product, and the collection of payment from the buyer of the product. (Please see our other articles on the cash conversion in the financial management category tab in topics of interest).
There are three ways to reduce the duration of the cash conversion cycle. The first is to manage accounts receivable so that collections are accelerated. This can be accomplished by more efficient and faster invoice processing, more restrictive credit policies, aggressive collection policies, and offering discounts as a reward for quicker payment.
The second way is to increase inventory turnover (conversely, reducing the number of days cash is tied up in inventory). This can be accomplished by using just in time inventory where the inventory is purchased as close as possible to the shipping date for the customer’s order. Also beneficial is implementation of proven techniques such as LEAN and Six Sigma which involve better planning and scheduling of production, matching production to demand rather than producing a pre-determined amount of inventory to reduce per unit costs, and measuring the tasks required to produce the inventory and minimizing the duration of these tasks without sacrificing effectiveness..
The third way is to lengthen the payment time for accounts payable. This is typically achieved by paying bills on the due date and maximizing payment float. The latter can be accomplished by zero balance accounts whereby the bank account is funded based on what is known will be disbursed the next day.
Since keeping cash in a bank account earns a tiny return, the CFO must investigate utilizing short term investments which are as liquid as a bank account, but earn a better return for the company. The vehicles for a short term investment strategy typically are: Treasury Securities, Repurchase agreements (REPOs), and commercial paper. Money market funds can also be utilized, but often require a management fee.
In our experience, more often than not, current assets are financed by short term debt. The CFO must find adequate and reliable sources of short term financing that meet the operating needs of the company. Important considerations include the ease of borrowing the money, minimal covenants, and cost considerations.
With regard to the cost, the CFO must find the most competitive all-in-cost. The key factors to consider are upfront fees, interest rate, and commitment fees. We suggest the CFO utilize a financial model (Excel is sufficient) to compare the all-in-cost of different lenders by calculating the all-in-costs for each under best case, worst case, and most likely case scenarios.
Short term financing is typically less costly than long term financing. In addition it is more flexible as it can be paid off at any time and matched with seasonal working capital needs. On the other hand, short term interest rates are variable and difficult to lock in, making future interest costs less certain. Furthermore, there is rollover risk which means the lender is unwilling to extend the loan term if a company’s cash flow is insufficient to pay off the loan at its due date.
Most successful small businesses have access to several desirable sources of funds. These include bank credit lines, letters of credit, commercial paper, securitization of receivables, and discounting receivables with a bank. However, some small businesses may not be judged creditworthy for such sources. In that case, alternatives include non-bank lenders like finance companies, business development companies, specialty lenders that usually take collateral valued at more than the amount of the loan, and factoring firms. These alternatives enable the firm to finance its assets, but are also more expensive and cumbersome than traditional means.
A key element of a firm’s liquidity and profitability is its working capital (current assets minus current liabilities). Converting accounts receivable and inventory to cash provides liquidity for paying creditors, investing in growth opportunities, and distributing cash to shareholders. The quicker this conversion occurs the more the company’s return on invested capital, in our view the most important measure of the firm’s profitability, is enhanced. The CFO oversees several working capital functions that determine the company’s liquidity and profitability.

Capitol CFO Solutions serves customers in Washington, D.C., Maryland, and Virginia. Please contact us for a free consultation.