Dakita Company

4384 Park Road, California

www.dakita.org

November 15, 2016

Chief Finance Officer

4384 Park Road, California

Dear CFO:

A business exists based on the idea that it should provide goods and services to customers, and ensures it generates a positive cash flow. The company will achieve desired results by using efficient methods that that would allow it to maximize the limited resources. Maintaining a positive cash flow is critical in determining the success of the company. Vendors would like to be paid on time so that they continue supplying raw materials, and other products and services to the company. However, although the company records positive sales, it faces a critical problem on cash flows. The company does not have enough cash to pay vendors or meet payroll within the required time. Therefore, the letter provides explanations to why cash can go down even when sales increase. In addition, the letter explains the three accounts that the Chief Financial Officer should review each day to manage the company’s cash flow.

Accounts receivable represents the company’s revenue that has not been collected as cash (Berk, DeMarzo, Harford, Ford, Mollica & Finch, 2013). Changes in account receivable are significant because it shows how the net income of the company differs with the actual cash inflow. The company’s problem is that it records an increase in sales but the cash still goes down. Since the company struggles to find money to pay vendors and other bills, it means that the account receivable is too high. The cash that the company receives will not increase until it collects money from customers.

Account receivable represents sales, and if the company could record an increase in sales without a corresponding increase in cash, then it means that customers have not fully paid for the good and services. The company’s source of cash inflow is the payment of account receivable, and since they usually extend credit to customers, they are likely to experience problems when customers do not settle their debts (Warren, Reeve, Duchac & Warren, 2012). In this situation, the unpaid account receivable will leave the company without the cash to pay vendors and settle other bills.

The company faces the problem of collecting money from customers, and that is the reason, the accounts receivable increases with a disproportionate increase in revenue. Therefore, the CFO should advise customers to pay for the good and services on time to avoid creation of cash shortage that would make the company unable to manage the cash outflow. The company can also borrow money to settle its debts. In situations when some customers decide not to pay their debts, the company would be forced to categorize these account receivables as bad debts.

The Chief Finance Officer should monitor specific accounts each day to ensure that there is smooth cash flow. First, the CFO should review accounts receivable. The monitoring of the account receivable is significant since it allows the company to manage receivables and prepayments received (Berk, et al., 2013). If the company recognizes revenue too early or fraudulently, then they will overstate the account receivable in the balance sheet. Similarly, if the revenue of the company comes from the sale of a product, then they will understate the inventory. The CFO should review accounts receivable to determine whether invoices have been sent to customers as quickly as possible. When customers receive invoices early, they can plan for an early repayment for goods and services they took on credit.

The second account that the CFO should review is the accounts payable. They are a significant part of the company’s short-term debts. Accounts payable is important because the company needs to know the money it owes suppliers (Warren, Reeve, Duchac & Warren, 2012). The company will list the sum of the amount it owes the suppliers as a current liability on the balance sheet. Due to the company’s limited capital access, it should avoid errors in managing cash flows and accounts payable. The mismanagement of accounts payable will result in a significant problem whereby the company will experience overdue payments (Warren, Reeve, Duchac & Warren, 2012). The accounts payable on the balance sheet will continue to show a positive balance until the company pays the bills for the good and services supplied.

Third, the CFO should review the cash account. Cash plays a major role in an organization since it is used to pay bills and other obligations (Warren, Reeve, Duchac & Warren, 2012). The CFO should monitor and review the cash account every day because if cash is improperly managed, then the company will face a major problem. The company distributes cash to cover both short-term and long-term liabilities. When the company distributed its cash to pay the existing liabilities, then the amount of asset in the balance sheet will reduce.

Sincerely,

Accounts Consultant, Dakita Company

References

Berk, J., DeMarzo, P., Harford, J., Ford, G., Mollica, V., & Finch, N. (2013). Fundamentals of corporate finance. Pearson Higher Education AU.

Warren, C. S., Reeve, J. M., Duchac, J. E., & Warren, C. S. (2012). Financial and managerial accounting. Mason, Ohio: South-Western Cengage Learning.

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