CASH MANAGEMENT Managing Your Business Dollars

Cash management involves forecasting, receiving, controlling, disbursing, and investing funds from your company's operations. Besides helping to improve liquidity and increase profits, effective cash management will: INCREASE CASH INFLOW. REDUCE CASH OUTFLOW. INCREASE THE YIELD ON IDLE FUNDS. Working with a certified public accountant (CPA) to establish an effective cash management system will enable you to stretch your business dollarsand in many instances, increase your earnings.

EVALUATE YOUR CURRENT SITUATION

CPAs can assist you in evaluating and improving your current cash management practices or in formulating new practices. The first step may involve a study of your financial statements and budgets, using various ratios such as the following: Accounts receivable turnover Average collection period Outstanding accounts receivable as a percentage of total revenue Inventory to current assets Inventory turnover Current assets to current liabilities Current liabilities to tangible net worth Total debt to equity Net profit on sales Once these ratios are developed and compared to industry norms, you can review your policies and procedures to determine the effectiveness of cash management.

FORECASTING CASH FLOW

Cash flow forecasts provide important data for estimating cash requirements, or investing idle funds not needed for day-to-day transactions. CPAs can help you develop cash flow forecasts using the following information:

Cash on hand. This should be easily determined from your accounting records. Expected cash receipts. These can be determined by estimating sales of goods or services, assets, and capital stock or securities. Expected cash disbursements. These can be determined by estimating the timing and amounts to be spent on operating costs, including:
Payroll and employee benefits Material and supply purchases

Taxes, dividends and interest Debt payments Capital acquisitions

ENHANCING CASH FLOW

Increasing the flow of money that your business takes in requires a careful analysis of your billing and collection procedures. Here are some points to consider:

Billing schedule. Should you mail your customers' monthly statements, bill them at the time of the transaction, or both? Under what situations are advance payments and progress billings desirable? CPAs can help you find the right answers to these questions. Early payment discounts. Should you offer your customers discounts for early payments? CPAs can analyze discount policies to determine if they are effective in speeding up collections. Credit and collection procedures. Who should be given credit and how can collections be improved? CPAs can recommend credit-granting policies. They can also evaluate the costeffectiveness of allowing customers to make payments using major credit cards, or of selling the accounts receivable to a third party. Deposit of cash receipts. Should you deposit daily cash receipts through a lockbox system, wire transfer or some other method? CPAs can prepare a cost analysis to determine the cost-effectiveness of each method. CONTROLLING CASH DISBURSEMENTS
Controlling cash disbursements to improve the availability of cash is a major objective of cash management. Minimizing the effects of cash outflow requires timing payments to maximize your use of funds, while maintaining good vendor relations. This may result in reduced borrowing costs. In addition, reducing operating costs in certain areas can help minimize your expenditures.

CPAs can help you determine when to make payments and if you should take advantage of early payment discounts. What's more, they can study inventory and purchasing policies to see if your company has maintained proper inventory levels, adopted the most cost-effective purchasing procedures, and determined the vendor with the most favorable terms.

INVESTING CASH
Investing your idle funds in appropriate vehicles earning interest or dividends may increase your company's earnings or minimize tax liabilities. CPAs can help you plan your investments and advise you of the tax consequences.

IMPROVING CASH MANAGEMENT

Developing a cash management plan requires a complex analysis of your business' policies and procedures. Because of their technical knowledge, training, and business experience, CPAs are particularly qualified to assist businesses in improving their cash management functions. They can analyze cash systems and make recommendations that will help you run your business more efficiently and profitably.

A CPA CAN HELP YOU

Review your current cash management system. Develop a budget. Forecast cash flow. Increase net cash inflow. Decrease net cash outflow. Select appropriate investments. Evaluate banking procedures. Improve your billing and collection policies. Analyze your inventory and purchasing practices. Reduce borrowing costs. Monitor managerial controls. By reviewing your cash management techniques, CPAs may recommend changes for immediate implementation, or for future benefithelping you to fulfill whatever plans you may have for your business' growth

Introduction This section introduces several terms and concepts that should facilitate the understanding of the dynamics and importance of sound cash management. It also sets forth objectives and procedures for examining the cash management function of Farm Credit System (FCS or System) institutions. Cash management refers to the practices and techniques designed to accelerate and control collections, ensure prompt deposit of receipts, improve control over disbursement methods, and eliminate idle cash balances. In general, the cash management function involves the effective and efficient use of cash to maximize cash flow at minimum cost. While System institutions generally do not maintain high cash balances, the cash management process is an integral part of an institution's financial activities and encompasses a wide variety of financial decisions. Such areas

can include information systems management, investment management, funds management, and liquidity management. The level of complexity and sophistication will vary among the district banks as well as associations because of size, available resources, technology and information systems, financial objectives, etc. In today's financial environment, electronic delivery systems are becoming increasingly important because of increased competition and the demand for more efficient and convenient capabilities. A significant number of transactions and amounts of funds can be moved electronically from one place to another almost instantaneously. Consequently, the opportunities presented can pose significant risks to a financial institution. Such threats include internal and external fraud, theft, and unauthorized manipulation of financial data. Examination Objectives The fundamental examination objective is to determine whether the institution's cash management activities are operated in a safe and sound manner. Specifically, examiners should:

Determine the adequacy of the board's and management's direction, control, and oversight of the cash management function. Determine compliance with applicable laws, regulations, policies, procedures, and other established guidelines. Determine the adequacy of corrective actions related to any weaknesses communicated during the preceding examination.

Examination Criteria Criteria for evaluating cash management activities include the Farm Credit Act of 1971, as amended (Sections 1.5 (14); 2.2 (10); 2.12 (18); and 3.1 (12) & (17)) and FCA Regulation 12 CFR 615.5134. These address FCS institutions' ability to use cash and investments to maintain sufficient liquidity and deposit or invest funds as authorized by FCA. Cash Cash includes cash items in the process of collection, currency and coin, and balances due from depository institutions. Cash provides flexibility and carries minimal risk in the short term. The amount of cash held will vary from institution to institution, depending on anticipated needs. For instance, liquidity needs, investment opportunities, and for associations the terms and conditions of the direct loan will affect cash balances held by the institutions.

Because cash is considered a nonearning or low-earning asset, excessive cash balances can have an adverse effect on earnings. As such, an opportunity cost associated with maintaining cash balances exists because these funds could be invested or applied elsewhere to provide a better overall return to the institution. Excessive balances may also reflect ineffective administration of the institution's resources by management. Conversely, account balances that are too low could leave the institution in a vulnerable position from an available funds standpoint. The risks and costs of holding this asset must be adequately managed to ensure the safety and soundness of the institution. Examiners should determine if the amounts carried are reasonable in relation to the institution's primary financial goals. Elements of a Cash Management System The basic premise of sound cash management is to ensure that cash inflows (sources of funds) and outflows (uses of funds) are effectively controlled and utilized. To effectively control cash flow, institutions must implement adequate cash management techniques to expedite cash collections and check clearing in order to access and use the funds. Institutions must also develop cost-effective disbursement mechanisms for transferring funds. The board and management are ultimately responsible for selecting the best collection and payment mechanisms as well as adopting appropriate oversight and review guidelines, operating policies and procedures, and audit requirements. In some cases, institutions may deploy other financial institutions and organizations for cash management related services that can be performed more economically or efficiently. Such services include transfer and payment of funds, collection and concentration of funds, sweep account services, information reporting, and so on. Before discussing the major elements of a cash management system, a general understanding of how float affects the overall collection and disbursement process is important. Float is caused by delays along the cash flow timeline. Float is usually measured in dollar days and is a function of the transaction's dollar amount and the number of days of delay. It is simply a means of quantifying the efficiencies or inefficiencies of the "cash in-cash out" cycle and focusing on opportunities and costs. An institution benefits from shortening all types of float associated with cash inflows and lengthening all types of float associated with cash outflows. The major components of float include mail, processing, availability, and clearing float. Collection An important component of the cash management function is the collection of funds. This process involves speeding up the conversion of receipts into available funds. By minimizing the float time associated with collection of accounts

receivable and extending the float on the accounts payable side, institutions can more effectively manage cash. Hence, institutions should effectively develop a system to collect payments from customers. Institutions may collect funds dropped off at their location, by mail, or electronically. For payments received in person or in the mail, an institution may use either its own processing center or a lockbox. In a lockbox system, an institution collects payments through one or more locations and transfers available funds to a concentration bank as discussed below. A processor (i.e., bank or any third party) receives mail at a specified lockbox address, processes the remittances, and deposits them in the institution's account. The economic benefit of using a lockbox is a trade-off between reducing collection float and paying fees to a lockbox processor over and above internal processing costs. Institutions can also collect payments electronically via wire transfer or an automated clearinghouse (ACH) system. Wire transfers are used for large dollar payments when speed and finality are important. Electronic payments through the ACH are less expensive than wire transfers, but payment instructions must be submitted to the bank 1 or 2 days prior to settlement. The primary advantages of an electronic collection system are the reduction in float and processing costs. Concentration This is the movement of funds from outlying depository locations to a central bank account, commonly called a concentration account, where the funds can be more efficiently used. The most frequently used methods for concentration are depository transfer checks (DTCs), electronic depository transfers (EDTs), and wire transfers. A DTC is an unsigned paper instrument payable only to the bank of deposit for credit to a specific account. Instead of writing and depositing checks to concentrate funds, an institution instructs a concentration bank to prepare DTCs drawn for deposit into the concentration account. After a DTC is deposited, it clears in the same manner as a regular check. An EDT is simply an electronic version of the paper DTC (also known as an ACH-DTC) and is normally more cost-effective. Wire transfers may also be used for concentration but is the most expensive method. They are generally used when the amounts are large enough to justify their cost and where funds are immediately needed. When designing an effective cash concentration system, institutions should carefully consider the costs involved, timing, and frequency of transfers. Time-zone problems and remote locations also are determining factors. Disbursement This involves controlling the release and timing of outgoing funds. Various disbursement techniques are available for institutions to effectively manage the disbursement process. These include checks, zero balance accounts, controlled disbursement, payable through drafts, and electronic disbursement methods.

Checks Checks are still the most frequently used payment instrument for bill paying and provide the payor with disbursement float. However, technological advances have increased the sophistication of check fraud. These technological advances include color copiers, high-resolution laser printers, and hand-held document scanners for use with a personal computer. Electronic payment methods help prevent check fraud by eliminating the check. Without a negotiable instrument, the counterfeiter has nothing to alter or copy. Furthermore, electronic payments (e.g., ACH) also offer strong cost savings potential by eliminating check printing costs, postage for mailing checks, and bank fees associated with check processing, account reconcilement, and check fraud prevention services. Zero Balance Accounts (ZBAs) A ZBA is a disbursement account on which checks are written even though the balance in the account is zero. A transfer of funds from the institution's master account covers the checks. Funding of the ZBA account is automatic and involves only an accounting entry by the bank. Credits and debits are posted just before the close of business when a credit from the master account is posted to bring the balance back to zero. If there is a credit balance in the ZBA account, the ZBA will be debited and a credit made to the master account. Controlled Disbursement Another method used to minimize balances in disbursement accounts is controlled disbursement. This is a bank service that provides same-day notification, usually by mid-morning, of the dollar amount of checks that will clear against the controlled disbursement account that day. The disbursement bank receives information from the local Federal Reserve Bank early in the morning so that the checks can be sorted and the institution notified of its funding requirement. Payable Through Drafts (PTDs) A PTD is a payment instrument resembling a check that is drawn against the payor, not the bank, and on which the payor has a period of time to honor or refuse payment. PTDs are used frequently to fund loans on capital items purchased by the borrower (e.g., equipment or livestock). The use of drafts gives the institution an added measure of disbursement control and additional time to ensure that all terms have been met or expenditures authorized. Electronic PTDs are simply ACH debits to an institution's account in which the institution is notified in time to pay or reject each item. They are used for similar purposes as paper PTDs.

Electronic Disbursements As with collection and concentration systems, disbursements can also be made electronically. As indicated previously, funds operated by wire transfers are moved almost instantaneously, thereby reducing float time, but are a costly way to disburse funds compared to checks and ACH transactions. Image technology can also be used to facilitate the processing of payments. This technology allows paper documents (e.g., checks) to be scanned and converted to digital information. The images may be transmitted to a computer and stored there, or sent to a fax machine. The increasing use of electronic commerce and potential cost savings are expected to stimulate growth in electronic payment systems as discussed in the following section.

Electronic Payment Systems The growing use and the reliance on the electronic transfer of funds expose an institution to additional risk in the management of cash. Each day, the institution's customers may make thousands of payments that result in the transfers of balances among the institutions, depository banks, and Federal Reserve Banks. In addition, institutions make their own payments in connection with carrying out their business. Because of electronic commerce, information moves faster and with greater accuracy. Consequently, the access and speed capabilities can magnify risk in an electronic environment. Since cash is a highly liquid asset, it can be easily transferred, concealed, and converted into other assets. For these reasons, institutions must have an adequate and effective information system (IS) in place. Coordination with IS examiners will be necessary to comprehensively evaluate an institution's electronic environment. While the range of electronic funds transfer may vary from institution to institution, the most common types of electronic payment systems include the following.

Automated Clearinghouse (ACH) System The ACH system was developed as an electronic alternative to checks. It comprises a network of regional associations, interbank associations, and private sector processors. The Federal Reserve is the principal ACH operator, and the majority of financial institutions are members of an ACH association. In an ACH transaction, payment information is processed electronically instead of manually, thereby increasing reliability, efficiency, and costeffectiveness. Institutions can make both credit and debit transactions with an ACH. In addition, an ACH transaction is capable of transferring more information about a payment than is possible with a check. Transactions are settled 1 or 2 business days after the payment information is entered into the payment system. In general, ACH

payments can be used in place of more costly wire transfers when the amounts are known at least 1 day in advance.

FedWire The FedWire is the Federal Reserve funds transfer system. It is a real-time method of transferring immediate funds and supporting information between two financial institutions using their respective Federal Reserve accounts. The system is reliable and secure but relatively expensive for institutions compared to checks and ACH transactions. The FedWire functions as both a communication (i.e., clearing) and a settlement facility. The FedWire service may be accessed by direct computer interface or off-line by telephone through a personal computer based electronic delivery system named FedLine. Funds are moved almost instantaneously once the originating bank has received the request. The transaction is final and irrevocable once the originating bank has sent the funds and the Federal Reserve confirms receipt. In the event of the sending bank's failure to settle, the Federal Reserve guarantees the transferred funds to the receiving bank. Therefore, there is no settlement risk to the recipient of a FedWire transfer. Nevertheless, other types of risk associated with the FedWire funds transfer method include potential loss because of errors, omissions, and fraud. Clearinghouse Interbank Payments System (CHIPS) This is a funds-transfer network owned and operated by the New York Clearinghouse Association to deliver and receive United States (U.S.) dollar payments between domestic or foreign banks that have offices located in New York City. CHIPS was established to substitute electronic payments for paper checks arising from international dollar transactions, such as Eurodollar investments or foreign exchange contracts. The network is composed of a small number of settling participants (large U.S. chartered banks that settle end-of-day balances between each other) and a larger number of non-settling participants who maintain accounts with one of the settling banks. Unlike FedWire funds transfers, CHIPS transfers are not settled at the time the payment instructions are delivered. Instead, the transfers are settled at the end of the day through a net settlement arrangement established with the Federal Reserve Bank of New York. Society for Worldwide Interbank Financial Telecommunications (SWIFT) This is a nonprofit cooperative of member banks serving as a worldwide interbank telecommunications network based in Brussels, Belgium. It is the primary message system employed by financial institutions worldwide to transmit either domestic or international payment instructions. Unlike electronic funds transfer systems, SWIFT

only provides instructions to move funds. Messages are transferred requesting debits and credits and other types of messages to correspondent accounts. SWIFT does not have a settlement mechanism. Settlement occurs through FedWire, CHIPS, or other means. Complete elimination of risk from electronic funds transfer is an impossible task. However, the increasing use of electronic transfer activities makes it essential that each System institution clearly understands the risks inherent in these activities and be aware of the methods for possibly reducing these risks to an acceptable level. The next section provides a brief discussion of some of the sources of risk involved in the overall cash management operations. Types of Risks Risks are inherent in all operational areas, including cash management. While cash has always been an area of high risk because of its liquidity, the risks have changed dramatically as a result of electronic media. Traditional currency is no longer the focal point of most institutions. Instead, electronic commerce moves incredible amounts of electronic money from one point to another almost instantaneously. Consequently, material losses could occur through error, inadequate controls, or fraud in electronic funds transfer systems. The following briefly identifies several types of risks associated with the cash management process. These risks are not all-encompassing or exhaustive by any means. Payment System Risk Payment system risk is the exposure to the uncertainty that settlement will occur. The failure of one participant to settle deprives other institutions of expected funds and prevents those institutions from settling in turn. Fraud Risk Fraud risk arises when a payment transaction is initiated or altered in an attempt to misdirect or misappropriate funds. Operational Risk Operational risk arises from the potential for loss because of significant deficiencies in system reliability or integrity. Security considerations are paramount, as institutions may be subject to external or internal attacks on their systems or products. Operational risks can also arise from customer misuse and from inadequately designed or implemented electronic banking. Credit Risk Credit risk is the risk that a counterparty will not settle an obligation for full value. Banks engaging in electronic banking activities may extend credit via nontraditional channels and expand their market beyond traditional geographic

boundaries. Institutions engaged in electronic payment programs may face credit risk if a third-party intermediary fails to carry out its obligations with respect to payment. In addition, the institution must ensure that it has adequate controls to ensure that electronic fund transactions are conducted in accordance with loan conditions and that funds are not disbursed in excess of undisbursed commitments. Liquidity Risk Liquidity risk arises from an institution's inability to meet its obligations when they come due without incurring unacceptable losses. Liquidity risk may be significant for institutions that transact significant amounts of electronic fund transfers if they are unable to ensure that funds are adequate to cover liquidity needs. Legal Risk Legal risk arises from violations of or nonconformance with laws, rules, regulations, or prescribed practices. Legal risk may also arise when the legal rights and obligations of parties to a transaction are not well established. Institutions can face legal risks with respect to customer disclosure and privacy protection. Many aspects of electronic transactions are relatively new and have not yet been established with court precedence. Reputational Risk Reputational risk is the risk of significant negative public opinion that results in a critical loss of funding or customers. Reputational risk may involve actions that create a lasting negative public image of overall institution operations, such that the institution's ability to establish and maintain customer relationships is significantly impaired. Service or product problems, mistakes, malfeasance, or fraud may cause reputational risk. Reputational risk may be affected by not only the institution itself but its affiliation with other institutions. Foreign Risk Foreign risk might exist for institutions dealing with other countries. Institutions dealing with foreign participants are subject to country risk to the extent that foreign parties become unable or unwilling to fulfill their obligations because of economic, social, or political factors. In addition, institutions accepting foreign currency for electronic payment may be subject to risk from the market because of movements in foreign exchange rates. Risk Management Process Risk management is an ongoing process of identifying, measuring, monitoring, and managing existing and potential risk exposure. Institutions should develop a risk management process to address known risks as well as remain dynamic enough to address risks that will undoubtedly surface in the future. An effective risk management program should minimize the negative effects of a problem situation. However, minimizing the potentially negative effects can be particularly difficult in

an electronic environment that offers speed, sophistication, and access to many users. Because of the risks associated with cash management activities, institutions should establish systems and processes to control these risks. The level and complexity of the risk management process should be commensurate with the risk characteristics of each System institution (i.e., district bank or an association). Additional details regarding the basic elements of a sound risk management process are provided below. Board and Management Responsibilities An effective risk management process requires appropriate direction, control, and oversight by the institution's board of directors (board) and senior management. An institution's board is ultimately responsible for ensuring that management takes the steps necessary to ensure the safety and soundness of the cash management system. They must define the institution's cash management philosophy and policies and ensure that the risks being taken by the institution fit within the overall business strategies and financial capabilities of the institution. The board is responsible for approving the overall policies of the institution with respect to cash management. The board should ensure that senior management has a full understanding of the risks incurred by the bank, and that the institution has personnel available who have the necessary technical skills to evaluate and control these risks. The board, or a designated committee, should periodically review information that is sufficient in detail and timeliness to allow it to understand and assess the performance of senior management. FCA Regulation 12 CFR 618.8440 also requires boards to annually adopt a 3-year operational and strategic business plan that considers factors that are likely to affect the institution during the planning period. Exposures to the risks associated with cash management should be reviewed as a part of this planning process. Senior management must ensure that cash management procedures and processes are in place to effectively monitor and measure cash management. Senior management should ensure that proper cash management procedures are developed and revised as necessary. Furthermore, senior management should develop, implement, and monitor the internal controls for cash management. Areas to be considered include clearly defining the individuals and/or committees responsible for managing cash-related activities, ensuring adequate segregation of duties, ensuring sufficient resources, and providing sufficient cross-training or backup of identified key personnel. Personnel in sensitive positions should be required to take uninterrupted holidays of sufficient length to exercise the organization's ability to cope with unavailability and to detect fraudulent activity. Policies and Procedures Proper cash management policies and procedures are

critical to implementing any sound cash management process. Institutions should have the board-approved policies that define its philosophy on cash management and procedures to implement the policy parameters. As indicated previously, cash is a highly liquid asset that can be easily transferred, concealed, and converted into other assets. As a result, institutions should have policies and procedures in place to direct and control the flow of cash from the time it is received, through the various stages of use and custody, to its final disbursement. The board should establish policies that address the objectives and operating parameters for maintaining cash. Generally, this would include target cash balances and a periodic analysis of the institution's cash needs. The complexity of an institution's cash management-related policies and procedures will vary greatly, depending on the type of institution. Small associations may have relatively simplistic procedures because of the minimal amounts of cash transactions. However, larger and more complex associations may require policies and procedures that are more in depth. For example, a System bank may have a policy that requires management to review and evaluate the institution's cash management process on a periodic basis to determine if:

Compensating balances or fees charged by depository institutions are cost-effective and comparable to the fees charged by other depository institutions. The financial condition of the depository institution is sound and deposits in excess of Federal deposit insurance are safe. New or alternative cash management services and techniques are available to further reduce costs.

System banks also would be expected to have extensive procedures in place, as they handle large cash transactions frequently. Internal Controls A system of effective internal controls is another critical component of cash management and a foundation for the safe and sound operation of any institution. In view of the potential for material loss, particularly through electronic activities, institutions must establish a strong internal control environment. The extent of an institution's internal control program should be commensurate with the complexity and sophistication of the activities in which it engages. As with many other aspects of institution operations, the type of controls used will vary but will likely consist of policies, procedures, operating parameters, monitoring activities, separation of duties, reporting, audit, and management information systems. For instance, policies and procedures should address the internal controls necessary to ensure cash is adequately safeguarded and recorded/reported to reflect actual balances

on hand. Segregation of responsibilities is one control that can be used to safeguard cash and reasonably ensure the reliability of accounting records. For example, the same person should not be responsible for recording the cash received on account and for posting the receipts to the accounting records. Signatory authorities and an effective internal audit function can also be used to provide additional controls over the cash management function. Auditing (internal and external) provides an important independent control mechanism for detecting deficiencies and minimizing risks in the cash management process. Institutions should conduct periodic reviews of its cash management process to ensure its integrity, accuracy, and reasonableness. They should ensure that individuals responsible for evaluating risk monitoring and controls are independent of the function they are assigned to review. Actions should be taken to ensure that personnel are following established policies and procedures, as well as ensuring that the procedures that are established actually accomplish intended objectives. Institutions should also have their cash management functions reviewed on a regular basis by an independent party, such as an internal or external auditor. The internal auditor should be separate and independent from employees making risk management decisions. To augment internal audit, management may seek qualified external auditors, such as cash management consultants or other professionals with relevant expertise, to provide an independent assessment of the cash management activity. The board and management should address the problems identified in the audits and correct any material weaknesses noted in a timely manner. Examiners should review the adequacy of the institution's internal controls to determine if the board and management are providing sufficient oversight in the area of cash management. However, examiners should exercise discretion in determining the scope of the cash management review based on the level of the institution's activities in this area. Monitoring and Reporting Ongoing monitoring and reporting are important aspects of any risk management process. For cash management activities, monitoring is particularly important because of the electronic environment and rapid changes that may occur with new innovations, such as the use of the Internet. In relation to information systems, two important elements of monitoring are system testing and auditing. Testing and auditing of systems operations can help detect unusual activity patterns and avert major system problems, disruptions, and attacks. Periodic reporting is also essential to ensure that the institution is complying with policy requirements and established parameters. More frequent reporting may be appropriate, depending on the institution's complexity and risk exposure. The reports provided to the board and senior management should be clear, concise, timely, and provide the information

needed for making decisions. Contingency Planning Contingency planning should be a routine part of any institution's business planning and operations. Contingency planning is basically a process of reviewing an institution's functions and assessing each area's importance to the viability of the organization. In the area of cash management, contingency plans can minimize business disruptions caused by problems that may impair or destroy an institution's processing and delivery system (i.e., communications equipment, computer equipment, and funds transfer network). The loss or extended disruption of the business operation presents substantial financial risk to the institution. Each institution should assess its own risks and develop strategies accordingly. An effective contingency plan covers all the bases of the institution's business operations and should be periodically evaluated and tested for adequacy and feasibility. Examination Procedures Examination procedures for funding and debt management are detailed in FCA Workpaper 4500. Close coordination with information systems, finance, and other examiners should be considered with respect to evaluating specific cash management activities and avoid duplication of efforts. Consistent with risk-based examination principles, examiners should add, delete, or modify procedures as needed based on the particular circumstances of the institution.

Defining Key Financial Ratios

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Corresponding to figures from your financial statements, ratios make relationships in your business more understandable. A ratio is only a shorthand note: It shows you what's going on according to your books. If your books are accurate portrayals of your business, here are 10 checkpoints to think about. Acid Test = Cash and Near Cash Current Liabilities Measures ability to meet current debt, a stringent test since it discounts the value of inventories. The rule of thumb is 1-to-1. A lower ratio indicates illiquidity. A higher ratio may imply unused funds. Current Ratio = Current Assets Current Liabilities Another measure of ability to meet current obligations. Less accurate than the acid test for very near term, but probably better a measure for six months to a year out, since it contains receivables and inventories as well as cash and near cash. The rule of thumb is 2-to-1, though this will be affected by seasonality. Receivables Turnover = Sales Receivables Measures the effectiveness of credit and collection policies. If your ratio is going down, collection efforts may be improving, sales may be rising, or receivables are being reduced. If your ratio is going up, sales credit policies may be changing, collection efforts may be flagging, or sales may have taken a nosedive. Caution: This ratio depends on when receivables are measured and the seasonality of the business. Careful bookkeeping is also essential. The same

applies to inventory turnover: Make sure that the measures are comparable from month to month. Use average receivables (inventories) if you can. Days Receivables = 30 Receivables Turnover Another way of looking at receivables. Particularly useful in explaining graphically what changes in credit and collection operations do to a business. Inventory Turnover = Cost of Goods Sold Average Inventory A measure of how well inventory is managed. Most businesses have a steady inventory turn. Compare your figures from year to year, asking yourself what causes the inevitable fluctuations. Small fluctuations are probably due to the flow of work. If you produce one jumbo jet a year, your inventory picture will be very different from that of a dealer of ripe tomatoes. Days Inventory = 30 Inventory Turnover Another way of monitoring inventory. This is controlled by your inventory ordering patterns (among other considerations), so be careful how you interpret it. Gross Margin Rate = Gross Margin Sales Permits comparison of margins over months with dissimilar sales. Ideally, this holds pretty steady in good months and bad -- but it depends on your business. It can distort fluctuations if sales are erratic. Net Profit Rate = Net Profit Sales An overall batting average: The aim is consistency over the long haul, not just short-term stardom. Return on Investment (ROI) = Net Profit Net Worth (Note: Net worth might show up on your financial statements as shareholder's equity.)Another profitability ratio, best looked at

occasionally, because it tends to magnify short-term shifts in thinly capitalized companies. Return on Assets (ROA) = Net Profit Total Assets A better profitability measure than ROI. ROA shows how well you're using your assets. However, since profits are a volatile short-term measure, this should also be taken with a grain of salt. The long-term trend is what matters. A large investment in fixed assets to handle growth will seriously alter this ratio. All ratios must be taken in context. The reason to look at them on a monthly basis is to make sure that you spot trends as they develop, not afterward. If you are doing something exceedingly well, you need to know it. And if something is wrong, it's better to find out sooner than later. This article was adapted from Chapter 11 of Financial Troubleshooting, by David H. Bangs Jr. and Michael Pellechia.

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Cash Management Texas State Auditor's Office, Methodology Manual, rev.5/94 Cash Management - 1 MANAGEMENT To collect, maintain, and disburse funds in a way that minimizes the risk of misuse, OBJECTIVE(S) Return to Table of Contents maximizes profitable cash flow, and supports the entity's operations and mission. BACKGROUND Cash is both a fundamental resource and the means by which the entity acquires other DEFINITIONS

(in alphabetical order) resources. To manage cash is to manage the entity's ability to purchase assets, service debt, pay employees, and control operations. Thus, effective cash management directly correlates with the entity's ability to realize its mission, goals, and objectives. The cash management process combines: ! cash management tools, such as cash budgets and cash forecasting, for controlling cash availability and maximizing the investment of idle funds ! procedures for collecting, disbursing, and investing cash ! internal controls for safeguarding, recording, and reporting cash This process must comply with existing laws and regulations, both federal and state, and applicable professional and ethical standards. The cash management process has three major subsystems: ! collection ! disbursement ! investment These subsystems have very different control objectives. For example, the collection subsystem should reduce the time between point of collection and actual deposit. The disbursement subsystem, on the other hand, should increase the time from point of disbursement to actual reduction of cash balances. Therefore, compatibility and coordination between subsystems is necessary for overall cash management objectives to be met. The Cash Management Improvement Act of 1990 substantially impacts the management of federal funds. This Act places restrictions on the timing of state drawdowns and requires the payment of interest for untimely transactions.

An Automated Clearing House (ACH) processes financial transactions via electronic bookkeeping entries. In contrast, a "regular" clearing house processes checks and other paper warrants. Direct deposits are ACH transactions. Cash is the basic unit of economic exchange. Cash may be currency or the right to draw currency. Since cash is immediately negotiable, it has the highest inherent risk of all assets.Cash Management Accountability Modules Cash Management - 2 Texas State Auditor's Office, Methodology Manual, rev.5/94 A cash forecast projects future cash needs and availability. The process need not be highly sophisticated. Cash management seeks to control cash availability and maximize investment yield on idle cash. It begins when the funds are received and ends when the expenditure is made (Allan, p. 3). Cash Management Improvement Act of 1990 (CMIA) governs the transfer of funds between federal agencies and states for federal grants and other programs. CMIA requires the timely transfer of funds between a federal agency and a state and the payment of interest where transfers are not made in a timely fashion. CMIA was effective for Texas state agencies on September 1, 1993. Texas colleges, universities, and other institutions of higher education are subject to the Act as of September 1, 1994. A concentration account is a central bank account into which available funds from other accounts are deposited for investment and out of which other accounts are funded for disbursements. It simplifies cash management by consolidating available funds in one location. A controlled disbursement account is a non-interest bearing account that is used to pay expenditures. Checks are written out of the account but the funds to cover the checks are not deposited until the check is presented to the bank for payment.

Depository transfer checks (DTC) are drafts requesting the transfer of funds from an entity's various deposit accounts to a central concentration account. Unlike checks, they are non-negotiable and can only be paid to the entity originating them. They are created by the concentration account and draw on the deposit account (Lipis, et al, p. 153). Float is the time between a payment transaction and the actual receipt and/or disbursement of funds at the depository. A cash transaction has zero float because the payment can be immediately used. All other payments must usually go through three stages of float: mailing, processing, and clearance. Collection float is the time elapsed between collection and availability of cash to the entity at its depository (Tolson, et al, 320). Disbursement float is the time elapsed between disbursement and actual deduction from the entity's available cash at its depository (Tolson, et al, 320). Lockboxes are mailboxes designated for the collection of cash. An appointed third party (bank or commercial vendor) intercepts the payments, processes them, and deposits them in a concentration account (Lipis, et al, pp. 151-152). The funds in a sweep account are automatically transferred (swept) to another depository at the end of each day.Accountability Modules Cash Management Texas State Auditor's Office, Methodology Manual, rev.5/94 Cash Management - 3 Wire transfers move funds from one depository to another by electronic means. It is usually a same-day transaction. They may be used to consolidate collection accounts, fund disbursement accounts prior to check clearance, and/or to transmit large sums for investment purchase (Lipis, et al, p. 159). A zero balance account is a bank account that has funds only when needed and otherwise

has a zero balance. These accounts can be used for collections and/or disbursements. When used for collections, they are called sweep accounts. Deposits are made daily into the account, and the balance is transferred at the end of the day to a concentration account. When used for disbursements, they are called controlled disbursement accounts. Checks are written out of the account, and funds are transferred from the concentration account as the checks clear. OVERVIEW OF THE The basic phases of a cash management process are (Allan, pp. 12-19): PROCESS The Systems Cycle: - Develop plans to meet cash needs. - Establish policies. - Establish specific objectives for each operating cycle. - Establish relationships with financial institutions. - Establish accounting systems. The Operating Cycle: Forecast cash flows. Collect and deposit collections. Make disbursements. Make investments. Track investments. Monitor, evaluate and audit the process. PROCEDURES Suggested procedures, organized according to the elements of a finding, are listed below. They should be expanded or tailored to fit the specific entity being reviewed. Note: The following procedures and the process described above are normative, rather than prescriptive. That is, they represent "average" or baseline thinking since they assemble information which repeatedly appeared in the various resources used to

prepare this module. Do not be too hasty or literal in applying a given criterion or procedural step to a specific entity. While omissions or variations may be obvious, judgment must still be used to determine whether such omissions or variations are material.Cash Management Accountability Modules Cash Management - 4 Texas State Auditor's Office, Methodology Manual, rev.5/94 Review criteria: General Criteria Specific criteria General criteria applicable to the cash management process are as follows: Cash management systems have five important objectives (Allan, pp. 3-7): ! Safeguard cash assets of the entity. ! Spport entity operations. ! Met legal obligations and constraints upon the entity. ! Povide adequate liquidity. ! Mximize cash availability and investment yield. Texas state entities may be required by the Treasurer to "implement a program for the rapid administration of deposits or transactions." These requirements may be waived when the Treasurer judges that the cost exceeds the benefit (Government Code 404.096). The criteria related to the basic phases of the cash management process are: The Systems Cycle The systems cycle is the basic overall plan for the cash management system (Allan, pp. 12-13). Develop plans to meet cash needs The entity should forecast its long-term (3-5 year) cash flow pattern. This is not a detailed cash forecast. Rather, it is a high-level financial forecast focusing on

sources and uses of cash. The forecast should analyze these various sources and uses of cash, such as capital expenditure, debt issuance, and debt repayment. The entity should then establish its general cash management objectives. Any conflicts between the cash management objectives and program goals should be resolved. The resulting cash management plan can then be used to propose more detailed policies to meet the entity's long-term goals (Allan, p. 13). Establish policies (Allen, pp. 13-14) The entity should establish cash management policies which cover both general and specific aspects of cash management. General cash management polices should establish responsibility and internal controls, define safekeeping and collateral procedures, and establish a system for monitoring and reporting performance as compared to objectives. They should also provide for compliance with legal and/or regulatory requirements and other applicable professional and ethical standards. Specific cash management policies should be developed for the following aspects of the subsystems of collection, disbursement, and investment: ! Collection: Identify the methods to be used to collect receipts and minimize collection float. ! Disbursement: Establish payment dates and payment methods to maximize disbursement float.Accountability Modules Cash Management Texas State Auditor's Office, Methodology Manual, rev.5/94 Cash Management - 5 ! Investment: Identify types and amounts of investments allowed, set standards for dealers or brokers, etc. However, a cost-benefit review of the proposed subsystem policies should be conducted before policies are finalized.

Establish specific objectives for each operating cycle (Allen, p. 15) Once the cash policies are established, the entity should specify cash performance objectives for each operating cycle. These individual objectives will depend on the entity's needs, provisions of governing statute(s), and the capability of each manager and related staff. Possible objectives include: ! Cash availability: Establishes the amount of cash regularly available to fund operations. For example, excess cash equal to one week's expenditures. ! Yield: The target rate of return desired on cash investment. This can be stated in terms of an absolute percentage or an amount above or below a specific index and should be benchmarked. ! Dollar return: Targeted interest earnings for the year. ! Efficiency: Percentage of idle cash to be kept invested during the year. Establish relationships with financial institutions All state agencies, other than institutions of higher education, are required to deposit funds to the Treasury within three business days (Government Code Section 404.094). However, under certain circumstances, deposits can initially be made to financial institutions. They must still be transferred to the State Treasury within three business days. Institutions of higher education "shall open in a local depository bank a clearing account to which it shall deposit daily all such receipts, and shall, not less often than every seven days, make remittances therefrom to the state treasurer . . ." Many of the receipts of these institutions, such as auxiliary enterprise funds, are exempt from this law (Education Code Section 51.008). If the entity deposits funds outside the State Treasury, it should consider the following factors when selecting a financial institution (Texas Comptroller of Public

Accounts, Financial Management., pp. 7-9): ! Financial stability - financial strength, including review of financial statement and audit report for the institution and its parent entity - the likelihood that the institutions holding its deposits and investments will be in business both during the current operating cycle and during the period(s) addressed in the cash management plan ! Services of the financial institution - scope of services - cost of services - timeliness of posting, transfer, loan approval, and other transactions as reasonably required by the entityCash Management Accountability Modules Cash Management - 6 Texas State Auditor's Office, Methodology Manual, rev.5/94 - correlation between the service areas of the depository and the entity - available rates of return - compensating balance requirements The entity should clearly set forth the services it expects, the expected volume of business, performance standards, and its preferred method for fee payment (Allan, p. 15). If the entity deposits more than is automatically insured by the FDIC, the institution should provide collateral for the excess. Many different kinds of collateral arrangements are possible. Requiring the collateral to be held by an independent third party provides the most security for the entity. The relative security of the collateral arrangement will affect the footnote disclosure required on the financial

statements by GASB #3. Depository banks selected by institutions of higher education to hold funds not required to be deposited in the Treasury are subject to the approval of the State Treasurer (Education Code Section 51.008). Establish accounting systems Sound cash management depends on the accuracy, reliability, and validity of the accounting systems used to control and safeguard the collection, disbursement, and investment of cash. The entity should have the following controls over cash, among others (SAO, ICSQ - Cash Balances, pp. 1-4): ! An adequate segregation of duties should exist between cash receipts, disbursements, deposits, recording, and reconciliations. For example: - Timely cash reconciliations should be performed by employees not responsible for issuance of checks/warrants or handling of cash. - Cash and appropriation reconciliations should be reviewed and approved by an employee independent of reconciliation preparation. ! All cash balances should be properly recorded and classified, and any restrictions on the availability of funds should be properly disclosed. ! Cash deposits should be adequately collateralized, and the entity should monitor collateral to ensure adequacy. The accounting and control systems for managing collections, disbursements, and investments (covered later in this module) should coordinate with each other, the cash management objectives, and entity policies, plans, goals, and objectives. The Operating Cycle The operating cycle is a series of regular, repetitive actions taken to manage cash

(Allan, p. 17).Accountability Modules Cash Management Texas State Auditor's Office, Methodology Manual, rev.5/94 Cash Management - 7 Forecast cash flows The operating cycle should begin with a comprehensive forecast of cash sources and uses. Sources include: revenues, grant proceeds, appropriations, sales proceeds, fees, etc. Uses include: expenditures, payroll, debt payments, etc. The entity's fiscal success depends on accurate forecasting of its cash position (Tolson, 310.01). In a government entity, this forecasting may need to occur within the context of a specific fund or fund type. Entities with the authority to accumulate excess cash and/or incur debt should forecast cash flows to ensure optimal resource use (Tolson, 310.02). These forecasts should be kept current to an appropriate operating period (daily, weekly, monthly, quarterly, etc.)(Tolson, 310). The entity should identify any restrictions on cash flow related to: ! federal grant requirements ! special revenue fund requirements ! debt service fund requirements ! trust fund requirements The cash flow forecast should also consider other factors such as: ! seasonal variations in activity ! contract terms ! collectibility The information developed in the forecast can be used to change or rearrange subsystem operations to adjust the availability of and return on investment cash as needed. For example:

! The forecast determines that federal funds must be disbursed within three days of receipt. Both the collection and disbursement processes will have to be adjusted to accomplish this. (Note that the Federal Cash Management Improvement Act requires that the drawdown of funds for major federal assistance programs be not more than three days prior to disbursement. For more information, see the SAO Federal Coordinators or the Methodology Project Information Resource Folder for Cash Management.) ! The forecast reveals that the entity will be receiving lump sum bond proceeds to be used to fund low-income housing loans. However, it will take three months to actually make the loans. The bond proceeds will need to be invested at a rate of return that will cover the bond interest payments in the interim. Collect and deposit receipts Management of cash receipts should focus on developing procedures within the subsystem that will ensure cash or its equivalent is received in a timely manner, properly recorded and credited, and deposited to the appropriate account as quickly asCash Management Accountability Modules Cash Management - 8 Texas State Auditor's Office, Methodology Manual, rev.5/94 possible. The objective is both to safeguard this highly liquid asset and minimize collection float. Control procedures for safeguarding receipts include, but are not limited to, (AICPA, Section 4600.190, p. 4613): ! Proper authorization of transactions: Assign cash handling and recording responsibilities from initial receipt to deposit to ensure continuous accountability. ! Segregation of duties: The person who deposits the receipts should not record the transaction.

! Design and use of adequate documents and records: Pre-numbered receipts should be used. ! Adequate safeguards over access to assets and records: Establish control facilities for protecting undeposited cash. ! Independent checks: Deposit slips should be reconciled to the bank statement. Management of the collection function focuses on shortening the time between receipt of these proceeds and availability to the entity at its depository, i.e. the objective is to minimize float. The entity's ability to maximize the total amount of revenues and receivables is a separate management process. The technological environment of today's banking/financial industry provides a wide variety of services to minimize float. Some of these techniques relate to the form the receipts take, and some relate to the processes used to transport receipts to the depository. All should be reviewed to determine that the transaction costs are not in excess of the interest earned on the additional float. Receipts can take many forms: cash, checks, wire transfers, and automated clearing house transfers. Some of these forms of receipts are more quickly deposited than others. To the extent possible, the entity should require remittances to be made in more readily available funds. For example, the State requires payments made on obligations over $250,000 to be made by electronic fund transfer (Government Code, Section 404.095). In addition, many different kinds of processes can be used to transport receipts to the depository, such as: lockboxes, mail, direct deposit, and personal delivery. Again, some of these mechanisms are quicker than others, depending on the nature, scope, and location of entity operations. Some processes for transporting receipts have the added benefit of making the

subsequent investment and/or disbursement more efficient. For example, bank accounts can be set up by individual field offices to allow immediate deposit of receipts to be swept daily into a concentration account that invests the funds. The number of offices collecting and depositing cash and the number of accounts receiving deposits should be limited, where practicable. Accountability Modules Cash Management Texas State Auditor's Office, Methodology Manual, rev.5/94 Cash Management - 9 Make disbursements Procedures in the cash disbursement subsystem should ensure that cash or its equivalent is disbursed timely, properly recorded and credited, and drawn from the proper account as slowly as possible. The objective is both to safeguard this highly liquid asset and maximize disbursement float. Control procedures for safeguarding disbursements include but are not limited to (AICPA, Section 4600.190, p. 4613): ! Proper authorization of transactions: Invoices/supporting documents should be provided to the signer prior to signing the check/warrant. ! Segregation of duties: Approval for disbursements should be separate from voucher preparation and purchasing functions. ! Design and use of adequate documents and records: Pre-numbered checks should be used. ! Adequate safeguards over access to assets and records: Access to and usage of warrant and check-signing machines and signature plates should be controlled. ! Independent checks: Signed checks/warrants should be compared to document control totals. The effective disbursement subsystem anticipates the need for cash to cover expenditures while maximizing disbursement float. By anticipating the amount and date

of payments, the amount of non-interest bearing cash balances required to fund draws on disbursement accounts can be minimized. Controlled disbursement accounts can be used to reduce the time the funds are in the non-interest bearing account. Methods for maximizing disbursement clearance float include but are not limited to (Allan, pp. 5760): ! Make disbursements out of a smaller institution that does not process items as quickly. ! Delay disbursements by maintaining demand accounts at a remote location. In determining the timing of disbursements, consideration should be given to the time requirements of the State Comptroller's warrant system. The disbursement subsystem should provide the data required to monitor cash account levels in a timely manner so that investments mature when checks clear, not when checks are written (Allan, p.18). Make investments One of the primary objectives of the cash management system is to maximize cash available for investment. Any cash so made available should be invested in accordance with the entity's investment policies. The characteristics of the investment selected should coordinate with the needs of the other cash management subsystems. For example, investment maturity dates should be coordinated with disbursement needs. To formulate decisions and make informed judgments, the cash manager depends on theCash Management Accountability Modules Cash Management - 10 Texas State Auditor's Office, Methodology Manual, rev.5/94 accuracy of the cash flow forecast, reports from the accounting system, and investment information from internal and external sources (Allan, pp.17-18). (See the module on Investments for more information.) Monitor, evaluate, and audit the cash management system

The entity should regularly measure and evaluate the achievement of all cash management objectives: cash availability, yield, dollar return, and efficiency. Material discrepancies should be reviewed to determine if changes should be made in the cash management process and/or plans, policies, and objectives. The entity should make sure that the cash management process is in compliance with applicable laws, regulations, and professional and ethical standards. The performance of the cash management system should align with entity goals and objectives. The process of monitoring, evaluating, and auditing is the step providing the bridge to tie the systems cycle to the operating cycle. Its absence or ineffective use can disrupt and endanger the success of what might otherwise be a thoughtfully and effectively designed cash management system (Allan, pp. 18-19).Accountability Modules Cash Management Texas State Auditor's Office, Methodology Manual, rev.5/94 Cash Management - 11 Assess Condition: Conduct interviews, observe operations, and identify and collect available Determine the actual process used Determine the strengths weaknesses of the actual process documentation in order to gain an understanding of the entity's actual cash management process and controls. Included in the actual process are both official/unofficial and formal/informal processes and controls. An actual process may exist even if it is not documented. Possible procedures include, but are not limited to: ! Determine where the cash management process resides in the entity, who participates in the process, how the participants are selected, and what and

their role is. ! Obtain and review any manuals, policies, and forms that could document any phase of the cash management process, including its relationship to entity goals, objectives, strategies, and plans. ! Determine if and how management consciously selects and employs the assumptions, criteria, methods, processes, and techniques used in the cash management process. Obtain and review available documentation on the assessment of risks, costs, and benefits. ! Determine how the entity plans its cash management and its relationship to the entity strategic plan. ! Determine the authority and responsibilities of key personnel. ! Determine the kind and frequency of monitoring over the cash management process and how monitoring information is communicated to appropriate authority/responsibility levels for action. In addition to gaining an understanding of the actual process, also try to find out: ! how the participants view the actual process ! what parts of the process they see as successful or unsuccessful ! what they think is important about the process and why This information may help identify causes and barriers. Using the tailored criteria, the understanding of the entity's process gained above, and the procedures in this section, analyze the actual process to determine if it: ! is designed to accomplish the management objective (this module, page 1) ! has controls that provide reasonable assurance that the process will work as intended ! is implemented and functioning as designed

! is actually achieving the desired management objective(s) Suggested procedures for each of these four analysis steps are detailed below. In executing these procedures, remember to identify and analyze both strengths and weaknesses.Cash Management Accountability Modules Cash Management - 12 Texas State Auditor's Office, Methodology Manual, rev.5/94 Identify and review the steps in the actual process to determine if the process is designed to accomplish the management objective(s). Possible procedures include, but are not limited to: ! Determine if all major steps in the criteria are included in the actual process. If steps are missing, determine if their absence is likely to have a materially negative effect on the cash management process at the entity you are reviewing. ! Determine if all steps in the process appear to add value. If there are steps that do not appear to add value, try to get additional information on why they are included in the process. ! Review the order of the steps to determine if it promotes productivity. For example, determine if cost/benefit analysis is performed before collection and disbursement methods are chosen. ! Review the level of technology used in the process to determine if it is upto-date and appropriate to the task. Besides computer, electronic, communications, and other mechanical technology, you should also consider what kinds of management technology are used (Gant charts, process maps, decision matrices, etc.). See the appendix to the module on Problem-Solving and Decision-Making for more information. Identify the controls over the process and determine if they provide reasonable assurance that the process will work as intended. These controls should be

appropriate, placed at the right point(s) in the process, and cost effective. Possible procedures include, but are not limited to: ! Draw a picture of the process, the controls, and the control objectives (see the graphic of the procurement process in the Introduction for an example). Flowcharts of the cash management process can help identify inputs, processes, and outputs. ! Determine if the control objectives are in alignment with the overall management objectives (this module, page 1). ! Identify the critical points of the process (i.e., those parts of the process most likely to determine its success or failure or expose the entity to high levels of risk) and the controls related to them. Consider whether the controls are: - in the right location within the process (input, operations, output) - timely (real time, same day, weekly, etc.) For example, determine the extent to which the cash management process exposes the entity to such risks as employee appropriation of funds for personal use or other revenue loss, withheld or delayed receipts or deposits, loss of interest on funds, available discounts not taken, errors in posting transactions, and diversion of funds from intended or mandated use. ! Compare the cost of the control(s) to the risk being controlled to determine if the cost is worth the benefit. ! Determine what controls are in place for monitoring and evaluating the overall effectiveness of the cash management process and making sure that changes are made in the process if it does not yield the desired results.Accountability Modules Cash Management Texas State Auditor's Office, Methodology Manual, rev.5/94 Cash Management - 13

! Identify, describe, and assess the process used to gather input from employees who might reasonably discover flaws in the process. Review observations, interviews, documentation and other evidence and design specific audit procedures to determine if the process and/or the controls have been implemented and are functioning as designed. Depending upon the objectives of the project, these procedures may include both tests of controls and substantive tests, more information on which is found in The Hub, pp. 2-B-8, ff. Possible procedures include, but are not limited to: ! Determine if any evidence of management override exists. ! Walk through the actual process, i.e., follow a transaction through the people and documents involved, and compare to the official process. ! Determine the extent to which cash management plans, policies, procedures, and practices conform to applicable laws, regulations, and other professional or ethical standards. ! Review evidence to determine how cash management performance criteria and evaluation is communicated to affected personnel and management. ! Review report files to determine if the actual frequency of reports matches the official frequency. Review the reports to determine if variances are reviewed and resolved. ! Review reports to determine that the quality and amount of reported data is appropriate for cash performance monitoring and evaluation. ! Review evidence to determine that cash reported on the balance sheet actually exists on that date; all cash balances are properly classified, described, and disclosed on financial statements; and represent assets to which the entity has legal rights.

! Select from the following tests of controls, as appropriate: - Observe mail processing to see that cash handling and record keeping are segregated and that logs are created immediately upon receipt. - Verify posting of receipt or disbursement to general ledger and proper use of the chart of accounts, applicable object code, and date. - Trace receipt to a valid deposit and bank statement. Verify restrictive endorsement of checks. - Note the time between receipt and deposit dates. If the three-day rule applies, estimate financial loss due to untimely deposit. - Trace the receipt or disbursement to an offsetting entry in the appropriate subsidiary ledger, if applicable. - Verify appropriate authorization of disbursement and voucher preparation and review. - Determine that the voucher disburses from the proper fund, account, and object code; that voucher amount, order quantity, payee, and dates of delivery and disbursement are correct; and that available discounts are taken. - Determine adequacy of physical control over checks, warrants, and vouchers.Cash Management Accountability Modules Cash Management - 14 Texas State Auditor's Office, Methodology Manual, rev.5/94 - Determine accuracy and thoroughness of roll-ups from receipt or voucher through (subsidiary) ledger(s) to financial statements. ! Select from the following substantive tests, as appropriate: - Review significant adjustments to material bank accounts in the

prior year made by the entity, Comptroller, or SAO. Determine if adjustments made by the entity are necessary and materially correct. Request bank confirmations on questionable accounts. - Determine that balances over FDIC coverage are secured by the financial institution, and trace security to documentation. - Tabulate and verify the proper double-entry posting of transfers between accounts occurring five days before and five days after the close of the fiscal year. Additional information on controls and tests can be found in the modules on Investments, Accounts Receivable, and Accounts Payable. Review and analyze any reports used by the entity to monitor the outcome(s) of the cash management process and/or any other information available to determine if the process is actually achieving the desired management objective(s) (this module, page 1). Possible procedures include, but are not limited to: ! Analyze these process reports over time for trends. ! Discuss any apparently materially negative or positive trends with management. Determine if and how management acts upon these trend reports and what changes, if any, were made in the process or controls as a result. Some process refinements, especially those affecting entity mission, goals, and outcome measures, may need to wait until the next appropriation cycle. ! Perform a time series analysis across multiple operating cycles of information contained in cash management plans, financial statements, key financial ratios, and proposed and actual budgets. Investigate significant fluctuations and determine the validity of explanations. See the Data Analysis module on time series analysis for more information. Accountability Modules Cash Management

Texas State Auditor's Office, Methodology Manual, rev.5/94 Cash Management - 15 Determine causes Determine what circumstances, if any, caused the identified weaknesses in the cash management process. Possible procedures include, but are not limited to: ! Determine if the participants in the cash management process understand the entity's mission, goals, and values and support them through their management of the cash management process. ! Determine if the participants understand both the purpose of and their role in the cash management process. ! If the process occurs at multiple locations, determine if there is a process for ensuring adequate communication and coordination among them. ! Determine if the relationship between the cash management process and other entity processes is clear. For example, you could compare the schedule of maturities for short-term investments with the monthly payable schedules to determine if the appropriate amounts were being retained in short-term investment or if more money could be shifted to long-term investment. You could review average balances in demand accounts to determine if monies were being swept to short-term investments in a prompt and effective manner. ! Determine if the cash management process has adequate resources -human, dollar, time, and hard assets. If they appear inadequate, determine if entity resources have been allocated according to the materiality of the cash management process relative to other entity processes. ! Determine if the entity has considered using alternative resources such as industry associations, non-profit organizations, academic institutions, or other governmental entities to meet its resource needs. ! Determine if resources available to the cash management process have been

allocated and used in a manner consistent with the importance of that resource to the cash management process. ! If there are negative trends in the monitoring reports, determine if the reports and their implications are communicated to and used by the appropriate parties to modify the process. Determine what internal or external constraints or barriers, if any, must be removed in order to successfully overcome these weaknesses. Possible procedures include, but are not limited to: ! Review the applicable entity, state, or federal laws or regulations to determine if any of them prevent the necessary changes from being made in the process. ! Determine if there are any key employees that are unwilling to change the process and why they are unwilling.Cash Management Accountability Modules Cash Management - 16 Texas State Auditor's Office, Methodology Manual, rev.5/94 Determine effect Compare the actual entity process to a recommended alternative process(es) and determine if each weakness in the entity process is material. Alternatives can be developed by using the criteria contained in this module, applying general management principles to the process, using the processes at comparable entities, etc. Materiality can be measured by comparing the dollar cost, impact on services (either quantity or quality), impact on citizens, impact on the economy, risks, etc., of the actual process to the recommended alternative process(es). Measurements can be quantitative, qualitative, or both. Possible procedures include, but are not limited to: ! Identify performance benchmarks (industry standards, historical internal data, other comparable entities, etc.) for the process in question and

compare to actual performance. Measure the difference, if possible. Include the cost of additional controls or changes in the process. ! Estimate the cost of the actual process and the alternative process(es) and compare. ! Estimate the quantity and/or quality of services provided the actual process and the alternative process(es) and compare. ! Identify the risks associated with the actual process and with the alternative process(es). Measure and compare the tasks. Develop recommendations Develop specific recommendations to correct the weaknesses identified as material in the previous section. In developing these recommendations, consider the tailored criteria, kind of process and control weaknesses identified, causes and barriers, effects, and additional resources listed at the end of this module. Possible procedures include, but are not limited to: ! Identify alternative solutions used by other entities. ! Identify solutions for removing barriers. ! Provide general guidelines as to the objectives each solution should meet; then the entity can tailor the solution to its specific situation. ! Provide specific information, if available, on how each recommendation can be implemented. RESOURCES Aho, James. "Forecasting Your Cash Flow." Credit Union Executive 31:2:17-22, JulyArticles August, 1991. Location: The University of Texas, Perry-Castaeda Library (Call InterLibrary Loan Office, 495-4134). Aziz, Abdul. "Cash Flow Reporting and Financial Distress Models Testing of Hypotheses." Financial Management 18:1:55-64, Spring 1989. Location: The University of Texas, Perry-Castaeda Library (HG 4001 F55). Carslaw, Charles A. "Developing Ratios for Effective Cash Flow Statement Analysis."

Journal of Accountancy 172:5:63-69 November 1991. Location: The University of Texas, Perry-Castaeda Library (HF 5601 J7). Caughlin, Garry W. "The Cash Management Discipline." CMA: The Management AccountingAccountability Modules Cash Management Texas State Auditor's Office, Methodology Manual, rev.5/94 Cash Management - 17 Magazine 62:2:4