Guide to Management Accounting CCC (Cash Conversion Cycle) for managers

Chapter 1

Now, why cash management is paying attention?

The financial statements consist of the profit and loss statement (P/L), the balance sheet (B/S) and the cash flow statement (C/F) and in general, sales, operating profit are more prioritized, but there seem to be many companies that cash management is regarded as an area of experts such as CFO (chief financial officer), business management, financial affairs persons.

In this chapter, I will tell you why cash management is paying attention.

(1) Profit is an opinion, Cash is a fact

Profit is just an opinion, cash is a fact. - one of favorite words of Mr. Tamotsu Iba, first CFO of Sony Corporation.

Although profits vary depending on the application of accounting standards, cash flow cannot be cheated. Because it shows how much money in and how much it went out. According to Mr. Iba, "Sony has been working on the consolidated management over a long time, and also started cash flow management relatively early among Japanese companies. There are different types of management indicators in the world and there is no absolute indicator. There is no end to the progress of management indicators. Operating income and operating cash flow show the matching movement in theory, but in fact, do not match because of the accounting standards. Accounting standards make it difficult to grasp the true profit.

Why do not match, you can be obtained useful information just to analyze it. For example, the stock does not affect the accounting of profits no matter how stacked up. On the contrary, even uncollected accounts receivable will get on profits. By thoroughly implementing cash flow management that excludes these opinions, inventories at the end of September were able to be compressed down to 40 days

(source: Quotations DB: leaders of Quotations)

(2) Increasing surplus bankruptcy

According to Teikoku Databank, the bankruptcy case of the listed company in the 2008 fiscal year when there was a Lehman shock became the worst after the war with 45 affairs, of which 21 were caused by insolvency due to liquidity problems.

On an account book, insolvency due to liquidity problems is being unable to continue as a company but going bankrupt by shortage of hand capital, although profits have come out. Four are raised as a big cause.

1)Excessive capital investment

When a debt occurs especially on the occasion of the purchase of land and equipment, it will be in the state where sales and profits do not catch up with payment.

2)Aggravation of raising funds

The cash outflow (cash out) for purchase and payment greatly exceeds the accounts receivable collection (cash in), the cash on hand is exhausted, and there is a disadvantage.

3)Insufficient working capital

On the profit and loss statement, accounts receivable that occurred during sales constitute profits, but since we have not received them as cash, in fact there is no increase in funds.

The working capital is briefly expressed as follows.

Working capital = accounts receivable + inventory - accounts payable

4)Problem of inventory control

If parts, raw material, or goods are bought in, on the balance sheet it will be appropriated as inventory. On the profit and loss statement, it seems that profits have come out with the increase of property. However, since it remains as inventory, it is not necessarily the increase in the profits by cash having increased.

It is said that the majority of bankrupted companies tend to carry over a large amount of inventory, excess inventory and the increase of slow-moving inventory. It is imperative to promote inventory dollar control and unit control from the management viewpoints.

Net income in the profit and loss statement does not represent all of the funds currently held by companies, but because of the fact that there are uncollected accounts receivable, there is a big difference between the amount of net cash on hand and net income.

Therefore, in order not to be in surplus bankruptcy, as well as manage the movement of goods in the balance sheet and income statement, it is important to manage the movement of funds in the Statement of Cash Flows (in particular operating cash flow).

According to the Nikkei Shimbun of September 25, 2017, more than half of the 544 companies that went bankrupt in 2016 through their investigation of Tokyo Shoko Research said they had recorded a surplus in the final settlement of account. When the company starts selling products and services, the business seems to be on track, but need to pay particular attention to the monthly cash flow until the business stabilizes. The cause of surplus bankruptcy is not just deterioration of cash flow due to delayed collection of accounts receivable. They have reported that excessive inventory and capital shortage will also result in fatalities.

It turns out that surplus bankruptcy closely relates to accounts receivable, accounts payable and inventory.

Therefore, as a method that does not become surplus bankruptcy, you can make a payment cycle faster, adopt a prepayment system, delay your company's payment, and so on.

As there is a word cash flow management, it is important how much cash funds you have at hand for the company to survive. When analyzing a company, it is necessary to confirm not only the balance sheet and the profit and loss statement but also the cash flow statement.

(3) Increasing Accounting Fraud

The accounting fraud means to intentionally misrepresent financial statements in order to deceive users of financial statements, or to not record the amount to be posted or to make necessary disclosure.

In general, fraudulent accounting can be classified into the category of (1) illegal sales advancement / fictional accounting, (2) postponement and no record of expenses, (3) evaluation change of assets, fictitious recording, (4) evaluation change of liabilities,

These are done by (i) counterfeiting / alteration / tampering of accounting records and related documents, (ii) misstatement or exclusion in financial statements, (iii) inappropriate application of accounting standards, and so on.

Accrual factors of accounting fraud

Generally speaking, fraud is said to occur when three fraudulent risks, Opportunity, Motivation and Justification occur, it is called the fraud triangle.

1)Opportunity

Opportunity is a workplace environment that you can do anytime you want to do cheating. For example, as an objective circumstance in the case of embezzlement, Authority is concentrated on one person in charge can be mentioned.

2)Pressure

Pressure is a feeling that has come to think that there is no choice but to carry out cheating in order to solve their own wishes and troubles. For example, as a subjective circumstance in the case of embezzlement, you are being suffering from debt repayment can be mentioned.

3)Justification

Justification is to overcome the punishment of conscience that you feel when fraudulent acts by accounting for reasons that are convenient for you. For example, as a subjective circumstance in the case of embezzlement, I borrowed temporarily instead of stealing, but I intended to return it can be mentioned.

Next, I will introduce the main methods for fraud accounting.

-Accounts Receivable: Concealed Accrued Accounts Receivable

-Inventory: overestimate or fictitious inventory

-Fixed assets: Excessive valuation (not impaired)

-Loans: imaginary loans

-Accounts payable: Fictitious accounts payable

-Sales: inappropriate sales record, fictional sales, circular transactions

-Cost of sales: deferred expenses

Fraud is intentionally done to gain unjust or illegal interests. Therefore, in order to generate profits on accounting,

-Increase sales

-Reduce costs

They will do accounting processing incentive works in two directions.

It is to make sales that is not real, defer the cost, postpone the loss, and show good profit. As a psychology to work injustice, it may be that there is a feeling such as It is painful now, even if I do wrong only now, the scraps will fit someday. However, companies are responsible for properly reporting and explaining corporate performance and financial condition through accounting, so the idea of It will be OK even if you do wrong only for this term does not apply.

Next I will introduce the outline of Kanebo and Toshiba whose accounting fraud amount exceeds 2,000 Oku yen.

1. The case of Kanebo’s accounting fraud

Kanebo was a historic prestigious company that led the Japanese economy with the textile business as a founder. In 2005, over the past five years, Kanebo's window dressing settlement was discovered with more than 2,000 Oku yen dressing accounting, the auditing firm ChuoAoyama Audit was suspended the audit work for 2 months by Financial Service Agency (FSA) in 2006. As a result, the auditing industry in Japan was forced to undergo major restructuring.

As cases of Kanebo's window dressing settlement, besides aggressive dressing such as overestimating sales, passive dressing such as removal from consolidated accounting settlement and hidden assets can be cited. Even if the company gets rid of the dressing up, it is inferred that since subsidiary with poor performance lacks the ability to raise funds on its own, most of the necessary funds receive direct loans from the parent company or raise funds using the guarantee etc. The table below is the main management index of Kanebo alone. Although it is comparable to the industry average in terms of profitability, it clearly shows abnormal figures for the management index of the balance sheet. (red color marked by author)

(source：Financial analysis method to distinguish bankruptcy dressing Yoshiaki, Suematsu, Chuo Keizai Sha)

※ Industry average： Tokyo Shoko Research Kanebo TSR Report March 2005

According to Mr. Yoshiaki Suematsu (Financial analysis method to distinguish bankruptcy dressing,Chuo Keizai Sha) , accounts receivable turnover, accounts payable turnover and inventory turnover are obviously questionable compared to the industry average, and there is a stagnation of working capital, such as funds refund transactions, which total about 1,727 Oku yen seems to be subsidiary related.

1)Accounts Receivable turnover

As compared with the industry average, the turnover is 3.73 months longer, which is equivalent to approx.725 Oku yen worth of accounts receivable.

(6.63 months - 2.90 months) × 19,435 Million yen = 72,493 Million yen

2)Accounts Payable turnover

As compared with the industry average, the turnover is 7.44 months longer, which is equivalent to approx.699 Oku yen worth of accounts payable.

(10.87 months - 3.43 months）× 9,397 Million yen = 69,914 Million yen

3)Inventory turnover

As compared with the industry average, the turnover is 1.56 months longer, which is equivalent to approx. 303 Oku yen worth of inventory.

( 2.63 months - 1.07 months）× 19,435 Million yen = 30,319 Million yen

2. The case of Toshiba’s accounting fraud

There has been described as there are three patterns for the modus operandi of the accounting fraud that occurred in the past in the feature article The origin of Toshiba corrosion in the Nikkei business of August 31, 2015.

-Pattern 1: cost falsification type

A deficit does not add up a loss by construction progress criteria, either.

In the case of Toshiba, electricity power and social infrastructure section, etc.

-Pattern 2: cost deferred type

Profit manipulated by way of the postponement of expenses and the profit was ahead of schedule in the future of the reduction expected. In the case of Toshiba, television and personal computer section.

-Pattern 3: assets inflated type

Although value has fallen, the appraisal loss of stock is not added up appropriately.

In the case of Toshiba, semiconductor section.

The third party committee pointed out that the total amount of misconduct is estimated to be 2,300 Oku yen for 6 years and 9 months from the fiscal year ended March 2009 to December 2014.

Fig. 1.1 (souce: Accounting fraud vs. Accounting standard, Yuji Hosono, Nikkei Business Publications)

1)Construction progress criteria

No provision for construction loss, No correction for change of increase in construction cost

2)Parts trade

Inappropriate transaction (inappropriate accounting of paid parts called Buy-Sell transaction*)

3)Expenses recorded

No expenses recorded by delaying receipt of invoices,

Even if losses occurred, loss is not posted due to pressure on achieving budget

4)Semiconductor Inventory

No devaluation for worthless accumulated inventory incurred by discontinued production because of pressure on profit

*Buy-Sell transaction means a transaction that sells parts to outsourcer once it is entrusted by a maker to a third party (manufacturing consignor), and then buys back after processing by the contractor. In general, it is called charge payment transaction, and Toshiba calls it as Buy-Sell transaction in internal terms and it is also used by other companies in the same industry.

An example is as follows.

First of all, in Buy-Sell transaction they sell parts with a cost of 20,000 yen to a consignee with 80,000 yen, and will purchase a PC of finished goods from a contractor with 85,000 yen after manufacturing a personal computer at a contractor.

The reason for selling parts with a cost of 20,000 yen for 80,000 yen is to make it unnecessary for the contractor to know the cost of parts. Since contractors have transactions with PC makers other than Toshiba, it is competitive disadvantage that parts costs are leaked to Toshiba's rivals, so it is called masking price and sells for 80,000 yen.

Of course, 60,000 yen, the difference between 20,000 yen and 80,000 yen, will be recorded as Toshiba's profit despite having no actual sales. In order to resolve this unrealized profit, they have to deduct 60,000