CASHBUDGET: THE STORY UNTIL YESTERDAY

Until yesterday, cashbudgeting was being performed on a “Monthly Total basis”:

Collections of May 290 Minus Payments of May 280 Plus Month End Balance of April 100

---------------

Month End Balance of May 110

This might look like a healthy picture, but if we take a closer look at the daily balance, then we might find that on the 5th the Cash Flow takes a nosedive, and it will turn positive again only after a large collection that’s due on the 25th. Now, if that large collection getsdelayed by 10 days, then onthe 31st we won’t haveenough funds to pay salaries.

Do we see that alarm going offin the “Monthly Average” picture?

NOWhat we need is a way to performCashbudget on a “Daily Balance basis”

Problem 1 (until yesterday unsolvable)

Every ERP in the world has a “so-called” cashbudget module. Yet throughout the world, finance professionals are still doing cashbudget on a spreadsheet. The reason for this inefficiency: We need to find a method to successfully consolidate two different “Data sets”.

If we try to create on May 2010 the cashbudget for the whole of 2010, in the ERP we have actual invoices for Jan to Apr (Data set 1), and based on them, the ERP can make a projection of the expected collections and payments. So far, every ERP can handle that task.

In order to reach all the way to Dec, we must incorporate values that have not happened yet, but are expected to take place (Data set 2). They can be found in the budgeting module, but they are in a concentrated form (example: expected sales of Sep 2010 = $10M). The challenge is to turn that concentrated data into values that are compatible with “Data set 1” (i.e. individual invoice on a daily basis). This is where all ERPs (including the Global leaders) have totally failed.

Problem 2 (until yesterday unanswered)

Try to Google for: “Financial Analysis Software” or “Investment Evaluation Program” etc. You will find programs that are: “Statistical ratio analyzers” or “Statistical report generators” or “Bank loan payment calculators” or “Stock portfolio related” or “Excel templates”.

What you could not find on a global scale (until yesterday), is a software that will accurately calculate the most obvious, and the most useful result in a Financial analysis scenario: Profit & Loss (example of result: profit of $5,379,287.17).

The reason for this inefficiency: no accurate and verifiable method of calculation of a result existed before. The (until yesterday) considered as state-of-the-art in calculation methods (NPV - IRR) is so inaccurate and problematic that no one really takes it seriously.

The solution to both problems is:

The C2BII calculation method is 100% accurate

Forecasts + Calculation Method = Result ±Α% ±Β% ±(Α+Β)%

When we create forecasts (for example: expected sales of Sep 2010 = $10M), we know that a level of inaccuracy is incorporated in them, depending on the quality of the forecaster’s work. Lets say that it is ±Α%. If we process those data with a method that has a built-in inaccuracy of ±B%, then the result is going to be ±(Α+B)% inaccurate.

One of the major advantages of C2BII is that its B = 0, or in other words, no inaccuracy is added to the result from the calculation method.

If anyone hopes that A and B in some scenarios might cancel each other out (for example A= +8.00% and B= -7.50%), then please note that:- Murphy’s Law states otherwise- Hoping is not a method

Why is the C2BII calculation method 100% accurate

One might describe C2BII as “Accounting 101 on steroids”.

One of its most important elements is how to turn concentrated info of “Data set 2” into daily “Analytical Lines”. That is being achieved by creating five simulations (think of accounting ledgers and you are very close to the concept). The values for the forecasted incidents will de entered into the system thru a “three level structure”:

Event Type - Impact Groups - Analytical LinesThe user will enter data from a User Interfacethat is simple to operate

Hint: Please notice the usageof a “Variation Factor”.We’ll talk about this later.

Event Type – Impact Groups – Analytical Lines

Since we are going to tweek “Accounting 101” in order to make it able to handle data in concentrated form, let us first see what entries would have taken place, if we were addressing individual invoices. We will work with an example of sales.

Since lines 1 and 5 cancel each other (over time), we are going to forget them and concentrate on lines 2,3 and 4, plus the entry in the “Warehouse Item Ledger” (since at Fiscal Year End we must be able to perform a valuation of “Residual Stocks of Goods” in order to establish the “Cost of Goods Sold”).

EVENT TYPESALES, 19% VAT, 60 DAYS OF CREDIT TO THE CUSTOMER

$100,000

IMPACT GROUP 1BANK ΒΥ

ACCOUNTING(Line 4)119%

$119,000

IMPACT GROUP 2BANK BYVALEUR(Line 4)119%

$119,000

IMPACT GROUP 3VAT

(Line 3)19%

$19,000

IMPACT GROUP 4ITEM

(WarehouseItem Ledger)

100%$100,000

IMPACT GROUP 5Profit & Loss

(Line 2)100%

$100,000

During set-up, under the relevant “Event Type”, we have created and associated with it, the “Impact Groups” that correspond to the Accounting entries that will happen.

Each “Impact Group” contains information about :

- the percentage of the sum of the entry that will be handled by it

- whether it is debit or credit

- its “Time Orientation” (whether it is a concentrated monthly entry, or a weekly entry etc), that determines the number of “Analytical Lines” under that specific “Impact Group”

- info about the date, on which the “Analytical Lines” are expected to occur

plus other relevant info.

Within the same time period, individual days bring different levels of sales. For example let us consider the weekly sales of a Super Market, that is closed on Sundays. On Friday afternoon and during all of Saturday the check-out lines are enormous, and so are the sales. Monday is a very quiet day.

So, if a company looks at the statistical data from the last 2 – 3 years (stored in the ERP), it might find that, on average, for every $100 sold on Saturday, $80 are sold on Friday, $20 are sold on Monday etc. In this example the break down might look like this:

So, if we are to distribute $100,000 among those days of the week, on the basis of those “Distribution Factors”, on Monday it would be:

100,000 * 20 / 320 = 6,250

And so on, for the other days of the week.

So, in our example, the break down into “Analytical Lines” will look like that:

These are the lines that will populate the five simulations (and their subdivisions, where applicable), that will create the equivalent of the Accounting ledgers, should those forecasts have actually taken place.

EVENT TYPESALES, 19% VAT, 60 DAYS OF CREDIT TO THE CUSTOMER

$100,000

IMPACT GROUP 5Profit & Loss

100%$100,000

ANALYTICAL LINES MON = 20 = 6,250.00 TUE = 30 = 9,375.00 WEN = 40 = 12,500.00 THU = 50 = 15,625.00 FRI = 80 = 25,000.00 SAT =100 = 31,250.00

SUN = 0 = 0.00 ----------------- -----------------TOTAL = 320 = 100,000.00

The end result is an accurate and verifiable calculation, because the underlying basis of the process is

“Accounting 101”

or in other words, a time tested and accepted method.

Here is a sample of the Bank Account simulation (or in other words, the Cash Budget) that was automatically constructed by the system, on a “Daily Balance basis”. Derivative incidents (examples: “Interest Income”, “Interest Expense”, “Payment of VAT” etc) are automatically calculated and registered by the system. The upper grid has the “Daily Total”, and if we click on a line, in the lower grid we will see the “Analytical Lines” that create that total.

“What if” Scenarios

In C2BII, numbers (both “user entries” and “set-up info”) have the capability to be associated with a “Variation Factor”, which consists of a “Variation Number” and a “Type of Action”. In order to quickly evaluate “What if” scenarios (example: we make only 92% of the forecasted sales), you simply change the “Variation Number” from 100 to 92 and perform a new Calculation. Every number that is associated with that “Variation Factor” will get changed into 92% of its original value, and the new calculation result will incorporate and reflect those changes.

All derivative incidents (examples: “Interest Income”, “Interest Expense”, “VAT Payments”, “Income Tax”, “Dividends Payable”, FX variations and valuation, valuation of residualstocks of goods at FY end etc) arerecalculated with the new values, andreflected in the new result.

C2BII Mode of Usage

C2BII does not work like an ERP, where there is a central database, whose integrity must be protected at any cost. On the contrary, users are encouraged to change whatever their intuition tells them it might be useful, without any damage to the system. A suggested usage, is thru these steps:

1. Installation of Software2. A person that is familiar with accounting and Tax laws performs the set-up3. The work so far gets saved in a “Base file”4. The “Base file” is distributed to other persons in the company5. A person that knows very little about Accounting and Finance takes delivery of the “Base file”, and loads it in his system 6. Immediately saves it under a new name (for example: “Investment1.c2bii” or “CashFlow1.c2bii”)7. Adds entries about relevant forecasts from a simple User Interface and utilizes “Variation Factors” 8. Saves the work so far, and then asks from the system to calculate the result

In that manner, even people that know very little about Accounting and Finance can find that all the infrastructure that is needed to support their work is already in place, by simply loading a “Base file”. By using it as their starting point they can produce in an extremely short timeframe, a calculation result, who’s quality and accuracy, until yesterday, was beyond the capabilities of the world’s best Financial Analyst.

Examples where C2BII is useful

Annual BudgetsCash Flow Budgeting

Investment EvaluationsSensitivity AnalysisProduct Price Policy“What if” scenarios

Example of a “Product Price Policy” scenario

You sell your product at $4.40 a piece and 60 days of creditIs it possible that if you sold at $4.20 a piece and 30 days of creditthe bottom line profit at “FY end, company total” level is better?

Even though only 4 numbers are involved, until yesterday the answer to thatscenario (thru the usage of NPV or IRR or thru any other method) was“Mission Impossible”.

Thru C2BII, all that is needed is that you change two “Variation Factors”(one for item price, and one for days of credit) in the company’s AnnualBudget file, and then hit the Calculate button.

C2BII is a global first in its field. It is the method (and the application) that will define the third generation of Financial Analysis.

The software tool that implements the new method is ready to sell, and currently in version 1.0.4

Charalampos Oikonomidis

http://www.c2bii.com/ info@c2bii.com

May 2010