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Accounting Best Practices, Fifth Edition by Steven M. Bragg Englewood, Colorado

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5–9. Include a Working Capital Analysis

All too many companies have found that their budgets are entirely unworkable because they have not accounted for the added cash required for working capital. This is a particular problem for those organizations forecasting extremely high rates of growth. They do not realize that they must have funds in advance to pay for the staff and materials required to produce products, as well as to fund the considerable increases in accounts receivable that will occur. Because of this, a company finds that its sales take off, as per the budget, while cash reserves rapidly dry up, resulting in a cash-starved organization that must scramble to find more cash to keep it growing. More times than not, a promising start is hamstrung because of lack of anticipation of working capital needs.

Clearly, the budget must account for working capital. There should be an extra page devoted to it in the budget, or it can be included in the cash flow page. In either case, the budget should make an assumption regarding the amount of inventory, accounts payable, and accounts receivable that will occur as sales go up; for example, there may be inventory turns of 12 per year, accounts receivable turns of 9, and accounts payable turns of 10. These turnover figures must then be built into the working capital formulas to determine how much extra cash will be needed as sales increase. An alternative approach is to assume that all working capital changes will be cleared in one ...

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