Proactive working capital management is essential to successful business operations. However, on average, businesses aren’t managing their working capital as efficiently as they have in the past, according to a new study by The Hackett Group, a digital transformation and AI strategy consulting firm.
The study found that all elements of the cash conversion cycle (CCC) deteriorated by an average of 1.3 days (or 4%) from 2022 to 2023. The sectors reporting the biggest CCC deterioration include marine shipping, biotechnology, oil and gas, and food and staples retail. Here’s why working capital management is so important, and how your business can avoid the trend revealed in the study.

Why working capital matters

Working capital equals the difference between current assets and current liabilities. Organizations need a certain amount of working capital to run their operations smoothly. However, excessive amounts can hinder growth and performance. The optimal amount of working capital depends on the nature of your company’s operations and its industry.

Working capital management is often evaluated by measuring the CCC, which is a function of three turnover ratios:
1. Days in accounts receivable outstanding,
2. Days in inventory outstanding, and
3. Days in accounts payable outstanding.

A positive CCC indicates the number of days a company must borrow or tie up capital while awaiting payments from customers. A negative CCC represents the number of days a company has received cash from customers before it must pay its suppliers. Cash businesses might have a low or negative CCC, while most conventional businesses have a positive CCC.

Ways to shorten your CCC

Here are three ways to reduce the amount your business has tied up in working capital:
1. Collect receivables faster. Possible solutions for converting accounts receivable into cash faster include: tightening credit policies, offering early bird discounts, issuing collection-based sales compensation and using in-house collection personnel. Companies also can evaluate administrative processes — including invoice preparation, dispute resolution and deposits — to eliminate inefficiencies in the collection cycle.

2. Reduce inventory levels. The inventory account carries many hidden costs, including storage, obsolescence, insurance and security. Consider using computerized inventory systems to help predict demand, enable data sharing up and down the supply chain, and more quickly reveal variability from theft.
It’s important to note that, in an inflationary economy, rising product and raw material prices may bloat inventory balances. Plus, higher labor and energy costs can affect the value of work-in-progress and finished goods inventories for companies that build or manufacture goods for sale. So rising inventory might not necessarily equate to having more units on hand.

3. Postpone payables. By deferring vendor payments when possible, your company can increase cash on hand. But be careful: Delaying payments for too long can compromise a company’s credit standing or result in forgone early bird discounts. Many organizations have already pushed their suppliers to extend their payment terms, so there may be limits on using this strategy further.

Make working capital a priority

Some businesses are so focused on the income statement, including revenue and profits, that they lose sight of the strategic significance of the balance sheet — especially working capital accounts. We can benchmark your company’s CCC over time and against competitors. If necessary, we also can help implement strategies to improve your performance without exposing you to unnecessary risk.

Accurate financial statements are essential to making informed business decisions. So, managers and other stakeholders may express concern when a company restates its financial results. Before jumping to premature conclusions, however, it’s important to dig deeper to evaluate what happened.

Uptick in restatements 

In June 2024, the Center for Audit Quality (CAQ) reported a recent uptick in financial restatements by public companies. The report, “Financial Restatement Trends in the United States: 2013–2022,” delves into a ten-year study by research firm Audit Analytics. It found that the number of restatements in 2022 had increased by 11% from the previous year.

More alarming is a trend toward more “Big R” restatements. Big Rs indicate that the company’s previously filed financial reports were deemed unreliable by the company or its auditors. Although most restatements are due to minor technical issues, the proportion of total restatements that were Big Rs rose to 38% in 2022, up from 25% in 2021. The 2022 figure is also up from 28% in 2013 (the peak year for restatements in the study) — and it’s the third consecutive year that the proportion of Big Rs has increased.

However, the CAQ report states, “It is too early to tell if the increase in restatements toward the end of the sample period is a true inflection point or simply a brief disruption of the previous downward trend.” Overall, financial restatements have decreased from 858 in 2013 to 402 in 2022.

Reasons for restatement 

The Financial Accounting Standards Board defines a restatement as a revision of a previously issued financial statement to correct an error. Whether they’re publicly traded or privately held, businesses may reissue their financial statements for several “mundane” reasons. For instance, management might have misinterpreted the accounting standards, requiring the company’s external accountant to adjust the numbers. Or they simply may have made minor mistakes and need to correct them.

Common reasons for restatements include:

1. Recognition errors (for example, when accounting for leases or reporting compensation expense from backdated stock options),
2. Income statement and balance sheet misclassifications (for instance, a company may need to shift cash flows between investing, financing and operating on the statement of cash flows),
3. Mistakes reporting equity transactions (such as improper accounting for business combinations and convertible securities),
4. Valuation errors related to common stock issuances,
5. Preferred stock errors, and
6. The complex rules related to acquisitions, investments, revenue recognition, and tax accounting.

Often, restatements happen when the company’s financial statements are subjected to a higher level of scrutiny. For example, restatements may occur when a private company converts from compiled financial statements to audited financial statements or decides to file for an initial public offering. They also may be needed when the owner brings in additional internal (or external) accounting expertise, such as a new controller or audit firm.

Material restatements often go hand-in-hand with material weakness in internal controls over financial reporting. In rare cases, a financial restatement also can be a sign of incompetence — or even fraud. Such restatements may signal problems that require corrective actions. However, the CAQ report found that only 3% of all restatements and 7% of Big Rs involved fraud over the 10-year period.

We can help

The restatement process can be time-consuming and costly. Regular communication with interested parties — including lenders and shareholders — can help businesses overcome the negative stigma associated with restatements. Management also needs to reassure employees, customers and suppliers that the company is in sound financial shape to ensure their continued support.

Accounting and tax rules are continuously updated and revised. So, your in-house accounting team may need help understanding the evolving accounting and tax rules to minimize the risk of restatements, as well as help them effectively manage the restatement process. We can help you stay atop the latest rules, reinforce your internal controls, and issue reports that conform to current Generally Accepted Accounting Principles.

In certain circumstances, businesses may need to hire CPAs to perform agreed-upon procedures (AUPs) instead of (or in addition to) a review or an audit. AUPs are a type of attestation engagement “in which a practitioner performs specific procedures on subject matter and reports the findings without providing an opinion or conclusion,” according to the standards set forth by the American Institute of Certified Public Accountants.

AUPs generally cost less and take less time than a review or an audit. Plus, their versatility allows them to address nonfinancial matters and dig deeper into items reported on your financial statements.

The basics

In general, an AUP engagement uses similar procedures to a review or an audit, but on a smaller and limited scale and with no assurance on the part of the CPA. An engagement letter is used to outline the scope and nature of the specific procedures that will be performed.

Upon completing AUPs, CPAs issue a written report that 1) describes the procedures performed and 2) summarizes the findings from each procedure. The accounting standards also require an AUP report to contain the following:

• A title that includes the word “independent” to show the report is from an independent accountant,
• Identification of the engaging party, the subject, and responsible party (if it’s not the same as the engaging party),
• The intended purpose(s) of the engagement,
• A statement that the practitioner didn’t conduct an examination or review,
• A statement that the practitioner doesn’t express an opinion or conclusion, and
• Reservations or restrictions concerning procedures or findings.

AUPs can be tailored to your organization’s needs and provide a targeted analysis into key areas of your business’s operations.

AUPs in the real world

Examples of areas where an AUP can provide clients and third parties with valuable insights include:

• Internal control evaluations,
• Grant compliance,
• Franchise agreement compliance,
• M&A due diligence,
• Construction project progress and spending practices, and
• Royalty payments under a licensing agreement.

Lenders also may want to confirm whether a company is in compliance with its loan covenants. Or if a lender waived a loan covenant violation during the year-end review or audit, the bank might request, as a condition of the waiver, that the borrower hire a CPA to perform AUPs to check on key financial metrics midyear.

We can help

AUPs are among the many services CPAs offer. These engagements can be a flexible, time-saving alternative (or add-on) to financial statement reviews and audits. But they have their limitations. Contact us to determine whether an AUP engagement is right for your situation.

With a median loss of $766,000, financial misstatement schemes are the costliest type of fraud, according to “Occupational Fraud 2024: A Report to the Nations,” a study published by the Association of Certified Fraud Examiners. Fortunately, auditors and forensic accountants may be able to detect financial statement fraud by testing journal entries for errors and irregularities. Here’s what they look for and how these tests work.

Suspicious entries

Statement on Auditing Standards (SAS) No. 99, Consideration of Fraud in a Financial Statement Audit, provides valuable audit guidance that can be applied when investigating fraudulent financial statements. It notes that “material misstatements of financial statements due to fraud often involve the manipulation of the financial reporting by … recording inappropriate or unauthorized journal entries throughout the year or at period end.”

Financial misstatement comes in many forms. For example, out-of-period revenue can be recorded to inflate revenue — or checks can be held to hide current period expenses and boost earnings. Accounts payable can be understated by recording post-closing journal entries to income. Or expenses can be reclassified to reserves and intercompany accounts, thereby increasing earnings.

To detect these types of scams, SAS 99 requires financial statement auditors to:

• Learn about the entity’s financial reporting process and controls over journal entries and other entries,
• Identify and select journal entries and other adjustments for testing,
• Determine the timing of the testing,
• Compare journal entries to original source documents, such as invoices and purchase orders, and
• Interview individuals involved in the financial reporting process about inappropriate or unusual activity relating to the processing of journal entries or other adjustments.

Forensic accountants also follow audit guidelines when investigating allegations of financial misstatement. And financial statement auditors may call on these experts when they notice significant irregularities in a company’s financial records.

Testing procedures

AICPA Practice Alert 2003-02, Journal Entries and Other Adjustments, identifies several common denominators among fraudulent journal entries. Auditors will ask for access to the company’s accounting system to test journal entries made during the period for signs of fraud.

Specifically, they tend to scrutinize entries made:

• To unrelated, unusual, or seldom-used accounts,
• By individuals who typically don’t normally make journal entries,
• At the end of the period or as post-closing entries that have little or no explanation or description,
• Before or during the preparation of the financial statements without account numbers, and
• To accounts that contain transactions that are complex or unusual in nature and that have significant estimates and period-end adjustments.

Other red flags include adjustments for intercompany transfers and entries for amounts made just below the individual’s approval threshold or containing large, round dollar amounts.

Getting professional help

Financial misstatement can be costly, but your organization can take steps to minimize its risk. External financial statement audits, surprise audits, and forensic accounting investigations can help identify vulnerabilities and unearth anomalies. Contact us for more information, including how we use computer-assisted audit techniques to review accounting transactions.

There are currently more than 33 million small businesses in the United States, according to the U.S. Chamber of Commerce. To succeed in today’s competitive markets, it’s essential for your business organization to have accurate books and records.

Bookkeeping vs. Accounting

For starters, you should understand the distinction between bookkeeping and accounting. Bookkeeping refers to the systematic storing of financial documentation, such as receipts, purchase orders, and invoices, as well as recording of daily financial transactions, such as purchases and sales of goods and services. In general, bookkeeping is the basis for accounting. Bookkeepers record journal entries — that is, debits and credits — for each transaction using accounting software, such as QuickBooks®, NetSuite®, or Xero™. However, bookkeepers do more than data entry; they also may be responsible for sending invoices, processing payments and payroll, conducting banking activities, and reconciling accounts.

Accounting involves classifying, interpreting and communicating financial transactions. Accounting uses the records maintained by the bookkeeper throughout the period to generate historic and prospective financial statements. These reports — balance sheets, income statements and statements of cash flow — provide financial insights that help management and external stakeholders evaluate financial performance.

2 methods

Business owners must choose a method for recording and classifying financial transactions. There are two main options for small and midsize businesses:

1. Cash accounting. Under this simplified method, a business records revenue when cash is received and expenditures (such as expenses and asset purchases) when they’re paid.

2. Accrual accounting. This method is prescribed under U.S. Generally Accepted Accounting Principles. Here, revenue is recorded when earned, and expenses are recorded when incurred, without regard to when cash changes hands. It’s based on the principle that revenue should be “matched” to the related expenses incurred in the reporting period. The chart of accounts for an accrual-basis business includes such items as accounts receivable (invoices that have been sent but haven’t yet been paid by customers) and accounts payable (bills that have been received but haven’t yet been paid).

It’s important to choose one accounting method and stick with it as you record transactions (a bookkeeping function) and prepare your financial statements (an accounting function). Some organizations start with cash accounting and switch to accrual accounting as they grow.

Getting professional help

Complying with accounting rules, tax laws, and payroll regulations can be overwhelming for many closely held businesses. Fortunately, you don’t have to go it alone. We can help you set up and maintain a reliable system of reporting financial transactions in an accurate, timely manner. Contact us for more information.