Contents

Cover

Series

Title Page

Copyright

Dedication

What This Book Will Do for You

Part One: Reports and Filings

Chapter One: Chief Financial Officer's Role and Reports

ROLE OF THE CHIEF FINANCIAL OFFICER

GOVERNMENTAL REPORTING

REPORTING UNDER THE SARBANES-OXLEY ACT

XBRL REPORTING

OTHER REPORTING

Chapter Two: Securities and Exchange Commission Filings

SEC RULES

S FORMS

SEC REGULATIONS

SOX REPORTING REQUIREMENTS

Part Two: Financial Reporting

Chapter Three: Financial Statement Reporting: The Income Statement

HOW IS THE INCOME STATEMENT PRESENTED?

REVENUE RECOGNITION

CONSTRUCTION CONTRACTS

EXPENSE RECOGNITION

Chapter Four: Financial Statement Reporting: The Balance Sheet

ASSETS

ACCOUNTS RECEIVABLE

INVENTORY

FIXED ASSETS

DISCLOSURE

LIABILITIES

ACCOUNTING FOR COMPENSATED ABSENCES

ENVIRONMENTAL OBLIGATIONS

EXIT OR DISPOSAL ACTIVITIES

FAIR VALUE MEASUREMENTS

FAIR VALUE OPTION FOR FINANCIAL ASSETS AND FINANCIAL LIABILITIES

STATEMENT OF CASH FLOWS

AVAILABLE-FOR-SALE AND HELD-TO-MATURITY SECURITIES

Chapter Five: Statement of Cash Flows

CLASSIFICATIONS OF CASH FLOW

ANALYSIS OF THE STATEMENT OF CASH FLOWS

Chapter Six: Accounting and Disclosures

ACCOUNTING CHANGES

FUTURES CONTRACTS

VARIOUS DISCLOSURES

Chapter Seven: Key Financial Accounting Areas

CONSOLIDATION

INVESTMENTS IN STOCKS AND BONDS

LEASES

PENSION PLANS

POSTRETIREMENT BENEFITS EXCLUDING PENSIONS

INCOME TAX ALLOCATION

DEFERRED TAX LIABILITY VERSUS DEFERRED TAX ASSET

TAX RATES

FOREIGN CURRENCY ACCOUNTING

TRANSLATION OF FOREIGN CURRENCY STATEMENTS WHEN THE FOREIGN CURRENCY IS THE FUNCTIONAL CURRENCY

INTERNATIONAL FINANCIAL REPORTING STANDARDS

Chapter Eight: Interim and Segmental Reporting

INTERIM REPORTING

SEGMENTAL REPORTING

Part Three: Cost Management and IT Systems

Chapter Nine: Cost Management and Analysis

WHAT IS COST MANAGEMENT AND ANALYSIS?

STRATEGIC COST MANAGEMENT

OVERHEAD COSTING

ACTIVITY-BASED COSTING

ACTIVITY-BASED MANAGEMENT

TARGET COSTING AND PRICING

Chapter Ten: Cost-Volume-Profit Analysis and Leverage

COST-VOLUME-PROFIT ANALYSIS

WHAT-IF ANALYSIS

SALES-MIX ANALYSIS

CVP ANALYSIS FOR NONPROFIT ORGANIZATIONS

LEVERAGE

Chapter Eleven: Short-Term Decisions

RELEVANT COSTS

BEST USE OF SCARCE RESOURCES

THEORY OF CONSTRAINTS

Chapter Twelve: Financial Forecasting, Planning, and Budgeting

FINANCIAL FORECASTING: THE PERCENT-OF-SALES METHOD

BUDGETING

SOME FINANCIAL CALCULATIONS

BUDGETING SOFTWARE

USING AN ELECTRONIC SPREADSHEET TO DEVELOP A BUDGET PLAN

LATEST GENERATION OF BUDGETING AND PLANNING SOFTWARE AND E-BUDGETING

Chapter Thirteen: Risk Management

ENTERPRISE RISK MANAGEMENT

AN APPROACH TO RISK MANAGEMENT

A CLOSE LOOK AT RISK MANAGEMENT

HOW TO REDUCE INVESTMENT RISK: DIVERSIFY

BETA—THE CAPITAL ASSET PRICING MODEL

ARBITRAGE PRICING MODEL

Chapter Fourteen: Capital Budgeting and Real Options

WHAT IS CAPITAL BUDGETING?

WHAT ARE THE TYPES OF INVESTMENT PROJECTS?

WHAT ARE THE FEATURES OF INVESTMENT PROJECTS?

TIME VALUE FUNDAMENTALS

POPULAR EVALUATION TECHNIQUES

LIMITED FUNDS FOR CAPITAL SPENDING

REAL OPTIONS

DISCOVERY-DRIVEN PLANNING

EFFECT OF INCOME TAXES ON CAPITAL BUDGETING DECISIONS

Chapter Fifteen: The What and Why of Responsibility Accounting

RESPONSIBILITY ACCOUNTING BASICS

COST CENTER PERFORMANCE AND STANDARD COSTS

FLEXIBLE BUDGETS AND PERFORMANCE REPORTS

PRODUCTION MIX AND YIELD VARIANCES

Chapter Sixteen: Control of Profit Centers

HOW DO YOU EVALUATE PROFIT CENTERS?

PROFIT VARIANCE ANALYSIS

Chapter Seventeen: Performance of Investment Centers and Transfer Pricing

RATE OF RETURN ON INVESTMENT

RESIDUAL INCOME

INVESTMENT DECISIONS UNDER ROI AND RI

TRANSFER PRICING

Chapter Eighteen: How to Analyze and Improve Corporate Profitability and Shareholder Value

MEASURES OF MANAGERIAL PERFORMANCE AND SHAREHOLDER RETURN

SUSTAINABLE RATE OF GROWTH

ECONOMIC VALUE ADDED

BALANCED SCORECARD

Chapter Nineteen: Information Technology and IT Systems

COMPUTER TECHNOLOGIES AVAILABLE FOR BUSINESS

ROLE OF INFORMATION SYSTEMS IN THE STRATEGIC PLAN

MANAGEMENT INFORMATION SYSTEMS

WHO USES EXECUTIVE INFORMATION SYSTEMS?

VALUE CHAIN MANAGEMENT SOFTWARE

EXTENSIBLE BUSINESS REPORTING LANGUAGE

WEB 2.0

CLOUD COMPUTING AND COMPARATIVE ADVANTAGE

MOBILE COMPUTING (WIRELESS TECHNOLOGY)

HANDHELD DEVICE SECURITY AND CONTINGENCY PLANNING

DISASTER RECOVERY AND BUSINESS CONTINUITY PLANNING

CFO'S VIEW OF INFORMATION TECHNOLOGY: A CURRENT SURVEY

Part Four: Management of Assets and Liabilities

Chapter Twenty: Working Capital and Cash Management

EVALUATING WORKING CAPITAL

CASH MANAGEMENT

CASH MANAGEMENT MODELS

BANKING RELATIONSHIPS

INTERNATIONAL CASH MANAGEMENT

Chapter Twenty-One: Management of Accounts Receivable

MANAGING RECEIVABLES

INVESTMENT IN ACCOUNTS RECEIVABLE

Chapter Twenty-Two: Inventory Management

INVENTORY RECORDING AND CONTROL

INVENTORY COSTS

ECONOMIC ORDER QUANTITY

REORDER POINT

HOW TO FIND THE OPTIMAL SAFETY STOCK SIZE

ABC INVENTORY CONTROL

SERVICE BUSINESS

Chapter Twenty-Three: Management of Payables

ACCOUNTS PAYABLE SYSTEM

MANAGING PAYABLES

Part Five: Financing the Business

Chapter Twenty-Four: Short-Term and Intermediate-Term Financing

SHORT-TERM FINANCING

INTERMEDIATE-TERM FINANCING

Chapter Twenty-Five: Long-Term Financing

TYPES OF LONG-TERM DEBT AND WHEN EACH SHOULD BE USED

ISSUANCE OF EQUITY SECURITIES

FINANCING STRATEGY

Chapter Twenty-Six: Warrants and Convertibles

WARRANTS

CONVERTIBLE SECURITIES

Chapter Twenty-Seven: Cost of Capital and Capital Structure Decisions

INDIVIDUAL COSTS OF CAPITAL

WEIGHTS

EBIT–EPS APPROACH TO CAPITAL STRUCTURE DECISIONS

ANALYSIS OF CORPORATE CASH FLOWS

COVERAGE RATIOS

CAPITAL STRUCTURE DECISIONS

Chapter Twenty-Eight: Dividend Policy

TYPES OF DIVIDEND POLICIES

VARIABLES TO BE CONSIDERED

Chapter Twenty-Nine: Financial Management of Multinational Corporations

FINANCIAL MANAGEMENT ESSENTIALS FOR MNCs

FOREIGN EXCHANGE MARKET

FINANCIAL STRATEGIES

TYPES OF FOREIGN EXCHANGE EXPOSURE

INTEREST RATE PARITY

PURCHASING POWER PARITY

APPRAISING FOREIGN INVESTMENTS

FINANCING

ANALYSIS OF FOREIGN INVESTMENTS

Part Six: Financial Analysis, Insurance and Legal Considerations, and Economics

Chapter Thirty: Financial Statement Analysis

FINANCIAL ANALYSIS ESSENTIALS

BALANCE SHEET ANALYSIS

POTENTIAL FOR BUSINESS FAILURE

INCOME STATEMENT ANALYSIS

MARKET VALUE RATIOS

ANALYZING THE FINANCIAL STRUCTURE OF THE FIRM

INDUSTRY CHARACTERISTICS INDICATIVE OF GREATER RISK

CONSIDERATIONS IN FOREIGN OPERATIONS

Chapter Thirty-One: Analysis, Evaluation, and Control of Revenue and Costs

CONTROL REPORTS

CONTROL OF COSTS

PERFORMANCE MEASURES

BUSINESS PROCESSES

Chapter Thirty-Two: Insurance and Legal Considerations

INSURANCE PROTECTION

TYPES OF INSURANCE

MEDICAL AND CATASTROPHE COVERAGE

LIABILITY INSURANCE COVERAGE FOR CFOs

BUSINESS LAW

Chapter Thirty-Three: Reading Economic Indicators

HOW CAN YOU KEEP TRACK OF THE ECONOMY WITH ECONOMIC AND MONETARY INDICATORS?

HOUSING-RELATED MEASURES

INDICES OF LEADING, COINCIDENT, AND LAGGING ECONOMIC INDICATORS

OTHER IMPORTANT ECONOMIC INDICES

MONETARY INDICATORS AND HOW THEY IMPACT THE ECONOMY

UNDERSTANDING ECONOMIC DATA AND INDICATORS

ECONOMIC INDICATORS AND STOCKS AND BUSINESSES

ECONOMIC INDICATORS AND BOND YIELDS

Part Seven: Liquidity and Treasury

Chapter Thirty-Four: Corporate Investments in Securities

CASH AND LIQUIDITY MANAGEMENT

TERMS AND FEATURES OF BONDS

OTHER FIXED INCOME INVESTMENTS

MONEY MARKET PREFERRED STOCK

PRIVATE EQUITY

CURRENT TRENDS IN LIQUIDITY MANAGEMENT STRATEGY

Part Eight: Taxation

Chapter Thirty-Five: Tax Factors in Financial Decision Making

WHAT SHOULD YOU KNOW ABOUT TAXES?

GROSS INCOME

DEPRECIATION

AMORTIZATION

TAX PLANNING

Part Nine: Mergers and Acquisitions, Divestitures, Failure, and Reorganization

Chapter Thirty-Six: Mergers and Acquisitions

VALUATION

FAIR MARKET VALUE OF NET ASSETS

CAPITALIZATION OF REVENUE

PRICE/EARNINGS RATIO

SIMILAR BUSINESSES

SALES OF STOCK

COMBINATION OF METHODS

SUCCESSFUL STRATEGY FOR MERGERS AND ACQUISITIONS

Chapter Thirty-Seven: Divestiture

WHY DIVEST?

ASSET VALUATION METHODS

PROFITABILITY METHODS

MARKET-BASED COMPARISONS

DISCOUNTED CASH FLOW ANALYSIS

DIVESTITURE WITH UNCERTAINTY

Chapter Thirty-Eight: Forecasting Corporate Financial Distress

PREDICTION MODELS

Z-SCORE MODEL

APPLICATIONS

Chapter Thirty-Nine: Failure and Reorganization

BUSINESS FAILURE

REORGANIZATION

Chapter Forty: Valuation of Bonds and Stocks

HOW TO VALUE A SECURITY

HOW TO VALUE BONDS

HOW TO VALUE PREFERRED STOCK

HOW TO VALUE COMMON STOCK

PRICE/EARNINGS RATIO APPROACHES

OTHER PRAGMATIC APPROACHES

THE BOTTOM LINE

Chapter Forty-One: Financial Statement Analysis: Key Financial Ratios and Metrics for Nonprofits

TREND ANALYSIS

ANALYSIS OF THE BALANCE SHEET

LIQUIDITY ANALYSIS

APPRAISAL OF SOLVENCY, CAPITAL STRUCTURE, AND NET ASSETS (FUND BALANCE)

EVALUATION OF THE STATEMENT OF ACTIVITIES

PERFORMANCE METRICS

SPOTTING POTENTIAL BANKRUPTCY AND AVOIDING FINANCIAL PROBLEMS

CASE STUDY IN FINANCIAL STATEMENT ANALYSIS

Appendix

About the Authors

Index

Founded in 1807, John Wiley & Sons is the oldest independent publishing company in the United States. With offices in North America, Europe, Asia, and Australia, Wiley is globally committed to developing and marketing print and electronic products and services for our customers’ professional and personal knowledge and understanding.

The Wiley Corporate F&A series provides information, tools, and insights to corporate professionals responsible for issues affecting the profitability of their companies, from accounting and finance to internal controls and performance management.

Copyright © 2012 by John Wiley & Sons, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.

Third edition (The Vest Pocket CFO) published in 2008 by John Wiley & Sons, Inc.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions.

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Library of Congress Cataloging-in-Publication Data:

Shim, Jae K.
CFO fundamentals : your quick guide to internal controls, financial reporting, IFRS, Web 2.0, cloud computing, and more / Jae K. Shim, Joel G. Siegel, and Allison I. Shim. — 4th ed.
p. cm. — (Wiley corporate F&A)
Rev. ed. of: The vest pocket CFO. 3rd ed. c2008.
  Includes index.
  ISBN 978-1-118-13249-4 (pbk.); ISBN 978-1-118-21955-3 (ebk);
  ISBN 978-1-118-21958-4 (ebk); ISBN 978-1-118-21960-7 (ebk)
  1. Corporations—United States—Finance—Handbooks, manuals, etc. I. Siegel, Joel G. II. Shim, Allison I., 1984– III. Shim, Jae K. Vest pocket CFO. IV. Title.
  HG4061.S48 2012
  658.15—dc23
2011037184

To Chung Shim, dedicated wife and mother;

Roberta M. Siegel, loving wife and colleague; and Sylvia and Arnold Siegel, loving mother and brother.

What This Book Will Do for You

Here is a handy pocket problem-solver for today’s busy chief financial officer (CFO). It’s a working guide to help you quickly pinpoint what to look for, what to be aware of, what to do, and how to do it in the complex world of business. You will find checklists, ratios, formulas, measures, guidelines, procedures, rules of thumb, illustrations, step-by-step instructions, real-life examples, tables, charts, and exhibits to help you analyze and evaluate any business-related problem. Throughout, you will find this book practical, quick, comprehensive, and useful.

Uses for this book are as varied as the topics presented. It can be used by CFOs employed by large, medium, or small companies.

You will be able to move quickly to take advantage of favorable situations and avoid unfavorable ones. Here is the guide that will help you make smart decisions. The book provides analysis of recurring problems as well as unusual ones that may occur and posts red flags of potential difficulties. It gives vital suggestions throughout on correcting financial sickness and inefficiency. The latest developments, such as new tax laws, are included.

The book covers the major areas and problems of corporate financial management and accounting. It is directed to the modern CFO who must follow some traditional elements common to controllership and financial management but must be cognizant of the ever-changing financial markets and technology of today. These factors make some of the traditional techniques of financial management obsolete; new strategies and techniques are necessary in order to do an effective job that ensures financial survival.

We present guidelines for evaluating proposals and for analyzing and measuring operations and activities and provide tips for preparing necessary reports.

The book is a practical reference that contains approaches and techniques for understanding and solving problems of:

Financial reporting: International Financial Reporting Standards (IFRS)

Cost management and information technology (IT) systems

Financial planning and budgeting

Management of assets and liabilities

Risk management and continuity planning

Liquidity and treasury

Financing the business

Real options and discovery-driven planning

Taxation

Mergers and acquisitions

Divestitures

Multinational finance

Forecasting corporate bankruptcy

Reading economic indicators

Part I (Chapters 1–2) covers the financial reporting responsibilities of the CFO, including the types of reports that must be prepared. Securities and Exchange Commission filings are required by public companies, and compliance with the Sarbanes-Oxley Act is required.

Part II (Chapters 3–8) discusses the financial accounting requirements applicable to the income statement, balance sheet, and statement of cash flows. Generally accepted accounting principles are delved into, including such important topics as leases, pensions, and accounting for income taxes.

Part III (Chapters 9–19) focuses on cost management and IT systems. It covers what the CFO should know about cost management and analysis, break-even analysis, contribution margin analysis, budgeting and financial modeling, variance analysis, risk management, portfolio diversification sustainable growth, capital budgeting, managerial reports, segmental performance, and quantitative techniques. Chapter 19 takes up the issue as to how IT assists CFOs in business decisions. It covers the use of information systems in all phases of business and in all functional areas to analyze and solve business problems in the real world. It covers topics such as cloud computing, Web 2.0, value chain software, and contingency planning.

Part IV (Chapters 20–23) addresses the management of working capital and assets including cash, accounts receivable, and inventory. The management of payables is also highlighted.

Part V (Chapters 24–29) deals with how to adequately obtain financing for the business to meet its goals and financial needs. Short-term, intermediate-term, and long-term financing requirements are discussed, and the circumstances under which each would be appropriate are indicated. Cost of capital determination and capital structure decisions are presented. The factors in establishing a dividend policy are noted. The financial management of overseas operations for multinational companies is explained.

Part VI (Chapters 30–33) is directed toward financial analysis areas, including risk/reward relationships and financial statement analysis for internal evaluation. Ways to analyze and control revenue and expenses are addressed. Proper insurance is needed to ensure the sustenance of the business. Knowledge of law is required to guard against legal exposure such as from product defects. The economic environment by way of economic indicators and statistics has to be studied to determine its impact on the business and what can be done in recessionary times.

Part VII (Chapter 34) covers investment portfolio selection so as to earn a satisfactory return while controlling risk. Current trend in corporate investment and liquidity management is also outlined.

Part VIII (Chapter 35) discusses the tax consequences of making financial decisions. Tax planning is essential to minimizing the tax obligation of the business.

Part IX (Chapters 36–41) presents the planning and financial aspects for mergers and acquisitions. The reasons and ways of divesting of business segments are discussed. The signs of potential business failure must be noted so that timely corrective action may be taken. The steps in a reorganization are discussed. Chapter 40 provides an in-depth treatment as to how to value a security. Chapter 41 addresses a special topic—financial analysis for nonprofit organizations.

The content of the book is clear, concise, and to the point. It is a valuable reference tool with practical applications and how-tos for you, the up-to-date knowledgeable CFO. Keep this book handy for easy reference and daily use.

PART ONE

Reports and Filings

CHAPTER ONE

Chief Financial Officer's Role and Reports

ROLE OF THE CHIEF FINANCIAL OFFICER

The chief financial officer (CFO) plays a strategic role in the company's goal-setting, policy determination, and financial success. The CFO's typical title is vice president of finance (VP Finance). Unless the business is small, no one individual handles all the financial decisions; responsibility is dispersed throughout the organization. The CFO's responsibilities include:

Financial analysis and planning: Determining the amount of funds the company needs; a large company seeking a rapid growth rate will require more funds.

Making investment decisions: Allocating funds to specific assets (things owned by the company). The financial manager makes decisions regarding the mix and type of assets acquired and the possible modification or replacement of assets, particularly when assets are inefficient or obsolete.

Making financing and capital structure decisions: Raising funds on favorable terms (i.e., at a lower interest rate or with few restrictions). Deciding how to raise funds depends on many factors, including interest rate, cash position, and existing debt level; for example, a company with a cash-flow problem may be better off using long-term financing.

Managing financial resources: Managing cash, receivables, and inventory to accomplish higher returns without undue risk.

The CFO affects stockholder wealth maximization by influencing:

Current and future earnings per share (EPS), equal to net income divided by common shares outstanding

Timing, duration, and risk of earnings

Dividend policy

Manner of financing

Exhibit 1.1 presents the functions of the CFO.

Exhibit 1.1 Functions of the CFO

A. Accounting and Control

Establishment of accounting policies and internal control

Development and reporting of accounting data

Cost accounting

Internal auditing

System and procedures

Government reporting and filings

Report and interpretation of results of operations to management

Comparison of performance with operating plans and standards

B. Planning

Long- and short-range financial and corporate planning

Budgeting for operations and capital expenditures

Evaluating performance

Pricing policies and sales forecasting

Analyzing economic factors

Appraising acquisitions and divestment

C. Provision of capital

Short-term sources; cost and arrangements

Long-term sources; cost and arrangements

Internal generation

D. Administration of Funds

Cash management

Banking arrangements

Receipt, custody, and disbursement of company’s securities and moneys

Credit and collection management

Pension money management

Investment portfolio management

E. Protection of Assets

Provision for insurance

Establishment of sound internal controls

F. Tax Administration

Establishment of tax policies

Preparation of tax reports

Tax planning

G. Investor Relations

Maintaining liaison with the investment community

Counseling with analyst regarding public financial information

H. Evaluation and Consulting

Consultation with and advice to other corporate executives on company policies, operations, objectives, and their degree of effectiveness

I. Information Technology and Management Information Systems

Development and use of information technology (IT) facilities

Development and use of management information systems

Development and use of IT systems and procedures

How do you differentiate among the controller, treasurer, and CFO?

If you are employed by a large company, the financial responsibilities are probably held by the controller, treasurer, and CFO. The activities of the controller and treasurer fall under the umbrella of finance.

There is no precise distinction between the jobs of controller and treasurer, and the functions may differ slightly between organizations because of size, company policy, and the personality of the office holder. In most businesses, the role of the controller is constantly changing and adapting to the situation at hand. The controller's functions are primarily of an internal nature and include record keeping, tracking, and controlling the financial effects of prior and current operations. The internal matters of importance to the controller include financial reporting, internal control and compliance, cost and managerial accounting, taxes, control, and audit functions. The controller is the chief accountant and is involved in the preparation of financial statements, tax returns, the annual report, and filings with the Securities and Exchange Commission (SEC). The controller's function is primarily to ensure that funds are used efficiently. He or she is primarily concerned with collecting and presenting financial information. The controller usually looks at what has occurred rather than what should or will happen.

Many controllers are involved with management information and IT systems, and review previous, current, and emerging IT patterns. They report their analysis of the financial implications of decisions to top management. Controllers are called on to establish, monitor, and analyze the internal control structure of the company to the extent that those controls impact the company's financial statements. At times, controllers may be called on to consider operational controls broader in scope. In particular, for SEC registrants that fall under Sarbanes-Oxley 404 requirements, controllers are required to obtain an independent auditor's opinion as to whether the control design and operating effectiveness are able to prevent a material misstatement in the financial statements. For entities that are not SEC registrants, much of the Sarbanes-Oxley 404 requirement could be considered best practice. In this regard, a risk-based control self-assessment program is a useful starting point. Tools such as internal control questionnaires or process maps may be useful. It is important to keep in mind that every company is different, and, therefore, the internal control self-assessment process should be tailored to the particular needs and peculiarities of each company. When designing a control self-assessment process or modifying controls, it would be prudent to obtain the external auditor's view at the onset to facilitate that auditor's function and lessen audit costs.

The treasurer's function, in contrast, is primary external. The treasurer obtains and managers the corporation's capital and is involved with creditors (e.g., bank loan officers), stockholders, investors, underwriters of equity (stock) and bond issuances, and governmental regulatory bodies (e.g., the SEC, Public Company Accounting Oversight Board [PCAOB]). The treasurer is responsible for managing corporate assets (e.g., accounts receivable, inventory) and debt, planning the finances and capital expenditures, obtaining funds, formulating credit policy, and managing the investment portfolio.

The treasurer concentrates on keeping the company afloat by obtaining cash to meet obligations and buying assets to achieve corporate objectives. While the controller concentrates on profitability, the treasurer emphasizes cash flow. Even though a company has been profitable, it may have a significant negative cash flow; for example, there may exist substantial long-term receivables (receivables having a maturity of greater than one year). Without adequate cash flow, even a profitable company may fail. By emphasizing cash flow, the treasurer strives to prevent bankruptcy and achieve corporate goals. The treasurer analyzes the financial statements, formulates additional data, and makes decisions based on the analysis.

The major responsibilities of controllers and treasures are summarized in Exhibit 1.2. Typically, both report to the chief financial officer. The CFO is involved with financial policy making and planning. He or she has financial and managerial responsibilities, supervises all phases of financial activity, and serves as the financial advisor to the board of directors. In the post-Enron era, the CFO’s role has taken on a whole new level of importance—nearly as important as the job of the chief executive officer (CEO). The new reporting rules instituted by the mandate of the Sarbanes-Oxley Act of 2002 (SOX; the Act) require that CFOs and CEOs sign off on their companies’ financials not once but twice. The certification puts CFOs at risk of criminal penalties for materially misrepresenting the numbers. That alone makes the CFO position more daunting.

Exhibit 1.2 Functions of Controller and Treasurer

Controller | Treasurer
Internal controls | Obtaining financing
Financial reporting–SOX, SEC, generally accepted accounting principles, International Financial Reporting Standards | Banking relationship
Risk management | Credit appraisal
Custody of records | Investment of funds
Interpretation of financial data | Investor relations
Budgeting and planning | Cash management
Controlling operations | Insuring assets
Appraisal of results and making recommendations | Fostering relationship with creditors and investors
Preparation of taxes | Collecting funds
Managing assets and IT systems | Managing assets

Exhibit 1.3 shows an organization chart of the finances structure within a company. Note that the controller and treasurer report to the VP Finance. For smaller companies, the controller is usually the CFO.

Exhibit 1.3 A Typical Financial Structure

The CFO must communicate important and accurate financial information to senior-level executives, the board of directors and its audit committee, divisional managers, employees, and various third parties. The reports must be prepared in a timely fashion and be comprehensible and relevant to readers.

The needs of management differ among organizations. Management reports should be sufficiently simple to enable readers to concentrate on problems and difficulties that may arise. The reports should not be cumbersome to read through; they should be consistent and uniform in format. The facts presented should be based on supportable financial and accounting data. The CFO should use less accounting jargon and more operating terminology when reporting to management. Also, the reports should generate questions for top management discussions.

What are prospective financial statements?

Prospective financial statements include financial forecasts and projections. This category excludes pro forma financial statements and partial presentations.

Financial forecasts are prospective financial statements that present the company’s expected financial position as well as results of operations and cash flows, based on assumptions about conditions actually anticipated to occur and on the management action expected to be taken.

A financial forecast may be presented in a single dollar amount based on the best estimate or as a reasonable range. However, this range cannot be selected in a misleading way.

In contrast, financial projections are prospective statements that present the company’s financial position, results of operations and cash flows, based on assumptions about conditions anticipated to exist and the action management is expected to take, given the hypothetical (what-if) assumptions.

Financial projections may be most useful to users who seek answers to hypothetical questions. These users may want to change the scenarios based on expected changing situations. A financial projection may contain a range.

A financial projection may be prepared for general users only if it supplements a financial forecast. However, financial projections may not be contained in general-use documents and tax-shelter prospectuses.

What should be contained in financial forecasts and financial projections?

Financial forecasts and financial projections may be in the form of complete basic financial statements or financial statements containing the following minimum items:

Sales or gross revenues

Net income

Gross profit

Basic and basic diluted EPS

Income from continuing operations

Income from discontinued operations

Unusual income statement items

Tax provision

Material changes in financial positions

Summaries of significant accounting policies and assumptions

Management's intent of preparing the prospective financial statements should be stated. However, there should be a mention that prospective results may not materialize. Also, it should be clearly stated that the assumptions used by management are based on information and circumstances that existed at the time the financial statements were prepared.

What are the various kinds of planning reports that can be prepared?

The CFO can prepare short-term companywide or division-wide planning reports. These include the forecasted balance sheet, forecasted income statement, forecasted statement of cash flows, and projections of capital expenditures.

Special short-term planning studies of specific business segments may also be prepared. These reports may relate to product distribution by territory and market, product line mix analysis, warehouse handling, salesperson performance, and logistics. Long-range planning reports may include 5- to 10-year projections for the company and its major business segments.

Specialized planning and control reports may include the effects of cost-reduction programs, production issues in cost/quality terms, cash flow plans for line-of-credit agreements, evaluation of pension/termination costs in plant closings, contingency and downsizing plans, and appraisal of risk factors in long-term contracts.

Why are information reports useful?

The CFO may prepare information reports for other members of top management. The reports can show and discuss long-term financial and operating trends. For example, the reasons and analytical implications of trends in revenue, production, and costs can be presented over the last three years. Although the format of such reports may vary depending on the environmental considerations and user needs, graphic depiction is often enlightening.

How can reports be used to analyze and control operations?

Reports can be prepared dealing with controlling financial activities and related analytical implications. Analytical procedures include comparing financial and nonfinancial information over time. The reports can highlight the reasons for significant change between prior- and current-year performance. For example, a sharp increase in promotion and entertainment expense or telephone expense may require investigation. Analytical reports are also used to summarize and evaluate variances from forecasts and budgets. Appraisal of variances may be by revenue, expense, profit, assets, product, division, and territory.

Why are exceptions to the norm significant to note?

Exception reports present detailed enumeration of the problems and difficulties faced by the business over a given time period. Such reports might zero in on internal control structure inadequacies or improper employment of accounting or auditing procedures in violation of generally accepted accounting principles (GAAP) and generally accepted auditing standards (GAAS). The computer should automatically output exception reports when a red flag is posted, such as when a customer’s balance exceeds the credit limit.

What should the board of directors know?

The board of directors usually is concerned with overall policy matters, general trends in revenue and earnings, and what the competition is doing. It is also interested in short-term and long-term issues. Relevant information in reports directed to the board of directors include company and divisional performance reports, historical and forecasted financial statements, status reports applicable to capital expenditures, and special studies. SOX requires an independent audit committee within the board. The board’s audit committee is responsible for the selection and oversight of the auditing certified public accounting (CPA) firm.

What special occurrences should be reported?

Special situations and circumstances may occur that require separate evaluation and study. For example, it may be necessary to identify the cause for a repeated decline in profitability of a given product, service, or territory. There may be a need for a feasibility analysis of whether to open a new store location or plant. Other reports may be in connection with union negotiations, commercial contract reviews, pension plan administration, bonus plans, and product warranty issues. It is essential that the reports contain narrative and statistical analyses of the decision with graphic presentations as needed.

What reports may segment managers find useful in decision making?

Reports prepared to assist divisional managers in evaluating performance and improving operating results include:

Dollar sales and volume

Profitability by product line, service, project, program, and territory

Return on investment and residual income

Divisional contribution margin, segment margin, and short-term performance margin

Actual and budgeted costs by cost center

Cash flow

Labor and plant utilization

Backlog

Comparisons of each division’s performance to other divisions within the company and to competing divisions in other companies

The CFO should determine whether current reporting may be improved. In one case, one of the authors, Professor Siegel, consulted with a company in which a maintenance and repair department manager prepared reports focusing solely on machine downtime. The reports concentrated on expenditures for repairs due to equipment breakdowns. Instead, the author recommended that the focus of attention should be on improving the productivity of manufacturing facilities. Hence, it is more constructive to look at uptime (machine usage) rather than downtime and to allocate resources accordingly. A machine uptime index may be computed. One can also analyze the production cycle period. This is the time between the receipt of an order and delivery to the customer, and it should be monitored on a regular basis.

How can reports be directed to improving quality?

Reports can be prepared with the view of improving the quality of goods and/or services while controlling costs. What is the cost effectiveness of contemplated quality improvements? Of course, there is a trade-off between better quality and increased costs. Attention should be directed to curing defects that cause project delays. Cost considerations include overtime, rework, scrap, and capital outlays. The reports should concentrate on the accumulated costs of actions that promote quality. The costs include material inspection, quality control, preventive maintenance, and sampling. The CFO should also consider the increased costs associated with poor-quality products and/or services, such as warranties, promotional expenditures to improve the company’s image, and legal liability settlements.

What types of information might interest employees?

Reports (see Exhibit 1.4) can be directed toward the interests and concerns of employees and contain this information:

Revenue and/or profitability per employee

Revenue relative to employee salaries

Assets per employee

Profit margin

Sales volume or service hours

Investments made to directly or indirectly benefit employees

Explanation of changes in benefit programs (e.g., health insurance, pension plan)

Percentage increase in salaries, fringe benefits, and overtime

Dividends relative to wages and number of employees

Corporate annual growth rate; comparison of employee salaries to that of competing companies and industry averages

Real earnings after adjusting for inflation

Analytical profit and cost information by responsibility center

Assets by business segment

Future prospects and problems in the company, industry, and economy

Break-even point

Actual and expected production

Employee safety

Compliance with federal, state, and local laws pertaining to employee working conditions

Sources of financing

Nature and type of assets held

Overall financial health of the company

Exhibit 1.4 ABC Company Statement of Revenue and Expense for Employees for the Year Ended December 31, 2X12

GOVERNMENTAL REPORTING

The CFO may have to prepare reports to federal, state, and city governmental agencies. Antitrust laws, environmental protection laws, pension laws, product liability laws, pollution laws, laws governing international trade and commerce, and tax laws are but a few of the myriad reports with which the company must contend. Penalties may be assessed for failing to file reports on time.

What does the New York Stock Exchange want to know?

The listing application to the New York Stock Exchange (NYSE) contains an agreement to provide annual and interim reports including financial statements and disclosures. The reports must be filed on a timely basis because the information they contain may have a material influence on the market price of stock, bond ratings, and cost of financing.

REPORTING UNDER THE SARBANES-OXLEY ACT

SOX has had a significant impact on CFOs and their reporting responsibilities. It has changed how public companies are audited and has made adjustments to the financial reporting system. The Act has also created the PCAOB to enforce professional standards. In addition, it has increased corporate responsibility and the usefulness of corporate financial disclosures. CFOs must personally attest to the truth and fairness of their company’s disclosures. The next provisions and requirements are promulgated under the Act as it applies to CFOs:

CFOs cannot engage in any action to fraudulently influence, coerce, manipulate, or mislead the independent auditor.

CFOs must certify in the annual report that they have reviewed the report and that it does not include untrue statements or omissions of material information.

CFOs must establish and maintain internal controls to ensure proper reporting.

CFOs are prohibited from falsifying records.

Pro forma financial data in any report filed with the SEC or in any public release cannot include false or misleading statements or omit significant information needed to preserve the integrity of the financial data.

The company’s audit committee is responsible for the selection and oversight of the auditing CPA firm.

An independent audit committee is required.

No insider trading is allowed during pension fund blackout periods.

Significant off-balance sheet transactions, arrangements, obligations, and other relationships must be disclosed. Disclosure must be made on material aspects related to financial condition, liquidity, resources, capital expenditures, and components of revenue and expense.

XBRL REPORTING

Extensible Business Reporting Language (XBRL) is an intelligent Internet language that can be used in business by preparers and users of financial statements including corporate accountants, CPAs, financial analysts, business managers (in reviewing reports), loan officers at banks, investors, suppliers, securities exchanges (e.g., NYSE), over-the-counter market members of Nasdaq, and federal and local governmental agencies (e.g., the SEC and Internal Revenue Service). By comparison, the Hypertext Markup Language (HTML) format is not intelligent enough as a language to understand and reveal relationships in accounting and financial data. HTML is not designed to be aware of the information it presents. XBRL closes the “communication gap” between the preparers and users of financial data on the Internet.

XBRL represents a major step forward in the preparation, publication, exchange, and analysis of financial data. It results in a simpler process for issuing financial reports and making investment and credit decisions. XBRL standardizes financial reports by clearly specifying and defining each item of data, using clearly defined tags. This allows XBRL-enabled software to accurately read and understand the figures, store them, and compare them.

The precise definitions, or tags, are necessary because terms such as “revenue,” “income,” “fees,” “stock,” and “inventory” can have a variety of meanings, depending on the organization. Humans use judgment to interpret financial data, but for computers to make sense of it, they need precise definitions. The SEC requires public companies to prepare interactive financial statement data in XBRL format by 2013. For more on XBRL, see Chapter 19.

OTHER REPORTING

Many groups, such as trade associations, state commerce departments, federal bureaus and agencies, and credit agencies, compile statistics on business performance. These groups receive and complete questionnaires and reports on a wide range of topics.

The CFO’s role in reporting information cannot be understated. Besides being able to formulate relevant financial and nonfinancial data, the CFO must be able to effectively and efficiently communicate that information to management, employees, government, investors, creditors, and other interested parties. The CFO should submit these reports in a timely way so that up-to-date information is available for decision-making purposes.

CHAPTER TWO

Securities and Exchange Commission Filings

THE SECURITIES AND EXCHANGE COMMISSION (SEC) requires full and fair disclosure in connection with the offering and issuance of securities to the public. The CFO should be familiar with the major provisions of the Securities Act of 1933 and the Securities Act of 1934.

The SEC's disclosure rules were enhanced by the Sarbanes-Oxley Act of 2002 (SOX), as detailed in Chapter 1. The accounting requirements of the SEC are specified mostly in Articles 3A through 12 of Regulation S-X, Financial Reporting Releases (FRRs), Accounting and Audit Enforcement Releases (AAERs), and industry guides.

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