Principles of Financial Accounting: Internal Control and Cash - Cash Management Strategies

What It Is

Cash management strategies are techniques used by companies to manage their cash inflows and outflows effectively. This is crucial in financial accounting as it directly affects a company's liquidity, profitability, and overall financial health. For instance, if a company buys $10,000 of inventory on credit, it needs to manage its cash flow to pay for the inventory within the agreed-upon payment terms.

Key Concepts & Formulas

• Cash Conversion Cycle (CCC): The time it takes for a company to sell its inventory, collect its accounts receivable, and pay its accounts payable. Formula: CCC = Days Inventory Outstanding (DIO) + Days Sales Outstanding (DSO) - Days Payable Outstanding (DPO). Example: A company has DIO = 30 days, DSO = 60 days, and DPO = 45 days. Its CCC would be 30 + 60 - 45 = 45 days.
• Days Sales Outstanding (DSO): The average number of days it takes for a company to collect its accounts receivable. Formula: DSO = Accounts Receivable / (Sales / 365). Example: A company has $100,000 in accounts receivable and $500,000 in sales. Its DSO would be $100,000 / ($500,000 / 365) = 73 days.
• Days Inventory Outstanding (DIO): The average number of days it takes for a company to sell its inventory. Formula: DIO = Inventory / (Cost of Goods Sold / 365). Example: A company has $50,000 in inventory and $200,000 in cost of goods sold. Its DIO would be $50,000 / ($200,000 / 365) = 73 days.
• Days Payable Outstanding (DPO): The average number of days it takes for a company to pay its accounts payable. Formula: DPO = Accounts Payable / (Purchases / 365). Example: A company has $30,000 in accounts payable and $150,000 in purchases. Its DPO would be $30,000 / ($150,000 / 365) = 73 days.
• Cash Ratio: A liquidity ratio that measures a company's ability to pay its short-term debts. Formula: Cash Ratio = Cash and Cash Equivalents / Current Liabilities. Example: A company has $50,000 in cash and cash equivalents and $100,000 in current liabilities. Its cash ratio would be $50,000 / $100,000 = 0.5.
• Operating Cycle: The time it takes for a company to sell its inventory and collect its accounts receivable. Formula: Operating Cycle = DIO + DSO. Example: A company has DIO = 30 days and DSO = 60 days. Its operating cycle would be 30 + 60 = 90 days.

Journal Entry Examples

Example 1: Cash Payment for Inventory

Dr. Accounts Payable $10,000 Cr. Cash $10,000

Explanation: This journal entry records the payment of $10,000 to a supplier for inventory purchased on credit.

Example 2: Cash Receipt from Accounts Receivable

Dr. Cash $5,000 Cr. Accounts Receivable $5,000

Explanation: This journal entry records the collection of $5,000 from a customer who owed money to the company.

Example 3: Accrued Salaries

Dr. Salaries Expense $5,000 Cr. Accrued Salaries $5,000

Explanation: This journal entry records the accrual of $5,000 in salaries expense that has not yet been paid.

Common Mistakes

Mistake 1: Confusing Debits and Credits for Expense Accounts

Correction: Expense accounts are debited, and asset accounts are credited.

Mistake 2: Not Recording Accrued Expenses

Correction: Accrued expenses should be recorded as a liability account and an expense account.

Mistake 3: Not Recording Accrued Revenues

Correction: Accrued revenues should be recorded as an asset account and a revenue account.

Exam Tips

Tip 1: Remember the Debit and Credit Rules

• Assets: Debit increases, credit decreases
• Liabilities: Debit decreases, credit increases
• Equity: Debit decreases, credit increases
• Revenues: Credit increases, debit decreases
• Expenses: Debit increases, credit decreases

Tip 2: Be Careful with Reversing Normal Balances

• Assets and expenses have normal balances on the debit side
• Liabilities and equity have normal balances on the credit side
• Revenues have normal balances on the credit side

Tip 3: Use the "ADE" Rule

• Assets: Debit increases
• Drawings: Debit decreases
• Expenses: Debit increases

Quick Practice

Problem 1: Accrued Salaries

A company has $5,000 in accrued salaries that have not yet been paid. What is the adjusting entry for accrued salaries?

Answer: Dr. Salaries Expense $5,000, Cr. Accrued Salaries $5,000

Explanation: This journal entry records the accrual of $5,000 in salaries expense that has not yet been paid.

Problem 2: Cash Payment for Inventory

A company pays $10,000 to a supplier for inventory purchased on credit. What is the journal entry for this transaction?

Answer: Dr. Accounts Payable $10,000, Cr. Cash $10,000

Explanation: This journal entry records the payment of $10,000 to a supplier for inventory purchased on credit.

Problem 3: Cash Receipt from Accounts Receivable

A company collects $5,000 from a customer who owed money to the company. What is the journal entry for this transaction?

Answer: Dr. Cash $5,000, Cr. Accounts Receivable $5,000

Explanation: This journal entry records the collection of $5,000 from a customer who owed money to the company.

Last-Minute Cram Sheet

• Dividends are NOT an expense – they go directly to retained earnings.
• Assets: Debit increases, credit decreases
• Liabilities: Debit decreases, credit increases
• Equity: Debit decreases, credit increases
• Revenues: Credit increases, debit decreases
• Expenses: Debit increases, credit decreases
• Cash Ratio = Cash and Cash Equivalents / Current Liabilities
• Operating Cycle = DIO + DSO
• DSO = Accounts Receivable / (Sales / 365)
• DIO = Inventory / (Cost of Goods Sold / 365)
• DPO = Accounts Payable / (Purchases / 365)