Accrued Wages And Taxes
Accrued wages refers to the amount of liability remaining at the end of a reporting period for wages that have been earned by hourly employees but not yet paid to them. This liability is included in the current liabilities section of the balance sheet of a business. Accrued wages are recorded in order to recognize the entire wage expense that a business has incurred during a reporting period, not just the amount actually paid.
For example, Mr. Smith is paid $20 per hour. He is paid through the 25th day of the month, and has worked an additional 32 hours during the 26th through 30th days of the month. This unpaid amount is $640, which the employer should record as accrued wages as of month-end. This accrual may be accompanied by an additional entry to accrue for any related payroll taxes.
The accrued wages entry is a debit to the wages expense account, and a credit to the accrued wages account. The entry should be reversed at the beginning of the following reporting period.
The accounts payable process or function is immensely important since it involves nearly all of a company’s payments outside of payroll. The accounts payable process might be carried out by an accounts payable department in a large corporation, by a small staff in a medium-sized company, or by a bookkeeper or perhaps the owner in a small business.
Regardless of the company’s size, the mission of accounts payable is to pay only the company’s bills and invoices that are legitimate and accurate. This means that before a vendor’s invoice is entered into the accounting records and scheduled for payment, the invoice must reflect:
- what the company had ordered
- what the company has received
- the proper unit costs, calculations, totals, terms, etc.
To safeguard a company’s cash and other assets, the accounts payable process should have internal controls. A few reasons for internal controls are to:
- prevent paying a fraudulent invoice
- prevent paying an inaccurate invoice
- prevent paying a vendor invoice twice
- be certain that all vendor invoices are accounted for
Periodically companies should seek professional assistance to improve its internal controls.
The accounts payable process must also be efficient and accurate in order for the company’s financial statements to be accurate and complete. Because of double-entry accounting an omission of a vendor invoice will actually cause two accounts to report incorrect amounts. For example, if a repair expense is not recorded in a timely manner:
- The liability will be omitted from the balance sheet, and
- The repair expense will be omitted from the income statement.
If the vendor invoice for a repair is recorded twice, there will be two problems as well:
- The liabilities will be overstated, and
- Repairs expense will be overstated.
In other words, without the accounts payable process being up-to-date and well run, the company’s management and other users of the financial statements will be receiving inaccurate feedback on the company’s performance and financial position.
A poorly run accounts payable process can also mean missing a discount for paying some bills early. If vendor invoices are not paid when they become due, supplier relationships could be strained. This may lead to some vendors demanding cash on delivery. If that were to occur it could have extreme consequences for a cash-strapped company.
Just as delays in paying bills can cause problems, so could paying bills too soon. If vendor invoices are paid earlier than necessary, there may not be cash available to pay some other bills by their due dates.
Trade credit is an important external source of working capital financing. It is a short-term credit extended by suppliers of goods and services in the normal course of business, to a buyer in order to enhance sales. Trade credit arises when a supplier of goods or services allows customers to pay for goods and services at a later date. Cash is not immediately paid and deferral of payment represents a source of finance.
Features of Trade Credit:
- There are no formal legal instruments/acknowledgements of debt.
- It is an internal arrangement between the buyer and seller.
- It is a spontaneous source of financing.
- It is an expensive source of finance, if payment is not made within the discount period.
Advantages of Trade Credit:
- It is easy and automatic source of short-term finance.
- It reduces the capital requirement.
- It helps the business focus on core activities.
- It does not require any negotiation or formal agreement.
Disadvantages of Trade Credit:
Like other sources of finance, trade credit is also associated with certain disadvantages, which are as follows:
- Trade credit is available only to those companies that have a good track record of repayment in the past.
- For a new business, it is very difficult to finance working capital through trade credit.
- It is very expensive, if payment is not made on the due date.
Working capital loans are as good as term loan for a short period. These loans may be repaid in installments or a lump sum at the end. The borrower should take such loans for financing permanent working capital needs. The cost of interest would not allow using such loans for temporary working capital.
Cash credit or bank overdraft is the most useful and appropriate type of working capital financing extensively used by all small and big businesses. It is a facility offered by commercial banks whereby the borrower is sanctioned a particular amount which can be utilized for making his business payments. The borrower has to make sure that he does not cross the sanctioned limit. The best part is that the interest is charged to the extent the money is used and not on the sanctioned amount which motivates him to keep depositing the amount as soon as possible to save on interest cost. Without a doubt, this is a cost-effective working capital financing.
Invoice discounting can be technically defined as the selling of bill to invoice discounting company before the due date of payment at a value which is less than the invoice amount. The difference between the bill amount and the amount paid is the fee of the invoice discounting to the company. The fee will depend on the period left before payment date, amount and the perceived risk.
The bills or invoices under bill discounting are legally the ‘bill of exchange’. A bill of exchange is a negotiable instrument which is negotiable mere by endorsing the name. For example our currency is an example of bill of exchange. Currency provides value written over it to the bearer of the instrument. In the case of bill discounting, such bills can be either payable to the bearer or payable to order. Therefore, after discounting a bill, a bank can further get the bill discounted from other banks in case of cash flow requirement.
Commercial paper is an unsecured, short-term debt instrument issued by a corporation, typically for the financing of accounts receivable, inventories and meeting short-term liabilities. Commercial paper is usually issued at a discount from face value and reflects prevailing market interest rates.
Commercial paper is an unsecured and discounted promissory note issued to finance the short-term credit needs of large institutional buyers.
Features of Commercial Paper:-
- The maturity period of commercial paper lies between 15 days to less than 1 year.
- It is sold at a discount but redeemed at its par value.
- There is no well-developed secondary market for commercial paper; rather they are placed with existing investors who intend to hold it till it gets matured.
Commercial Papers have a variety of benefits to both, the issuer as well as the investor.
There are a few important things to note about Commercial Papers, such as their rules, conditions and requirements.
Certificates Of Deposit
Certificate of Deposit (CD) implies an unsecured, money market negotiable instrument, issued by the commercial bank or financial institution, either in demat form or as a usance promissory note, at a discount to face value at market rates, against the amount deposited by an individual, for a stipulated time.
In finer terms, certificate of deposit is a fixed interest bearing term deposit, which has a fixed maturity. It limits the access to the funds, until the lock-in period of the investment, i.e. the depositor cannot withdraw funds, on demand.
Salient Features of Certificate of Deposit
- Eligibility: All scheduled commercial bank, not including regional rural bank and cooperative bank, are eligible to issue the certificate of deposit. It can be issued by the bank to individuals, companies, trust, funds, associations, etc. On the non-repatriable basis, it can be issued to Non-Resident Indians (NRIs) also.
- Maturity period: The CDs are issued by the bank at a discount to face value, at market-related rates, ranging from 3 months to one year. When a financial institution issues CD, the minimum term is one year and maximum three years. In addition to this, no grace period is allowed for the repayment of CD.
- Denomination: The minimum issue size of a certificate of deposit is Rs. 5,00,000 to a single investor. Moreover, when the certificate of deposit exceeds Rs. 5,00,000, it should be in multiples of Rs. 1,00,000. Add to that; there is no ceiling on the total amount of funds raised through it.
- Transferability: Certificate of deposit existing in physical form can be freely transferred by way of endorsement and delivery. CDs in dematerialised form can be transferred, as per the process of other dematerialised securities.
- Reserve requirement: Banks are required to keep CRR and SLR on the issue price of the certificate of deposit.
- Format: Banks and financial institutions can issue CD in dematerialised form only. Although the investor, at their discretion, can seek a certificate in traditional form. Moreover, it attracts stamp duty.
- Discount: Certificate of Deposit is issued at a discount to face value, determined by the market, which can be front end or rear end discount. The effective rate of discount is greater than the quoted rate in case of front end discount. On the contrary, in rear end discount, the CDs yield the quoted rate on the expiry of the specified term.
Banks issue certificate of deposit when the deposit growth is comparatively slow, and credit demand is high, and there is a tightening trend in the call rate. These are high-cost liabilities, and banks take recourse of CD’s only when there exist stiff liquidity conditions in the market.
Factoring is an arrangement whereby a business sells all or selected accounts payables to a third party at a price lower than the realizable value of those accounts. The third party here is known as the ‘factor’ who provides factoring services to business. The factor would not only provide financing by purchasing the accounts but also collects the amount from the debtors. Factoring is of two types – with recourse and without recourse. The credit risk of nonpayment by the debtor is borne by the business in case of with recourse and it is borne by the factor in the case of without recourse.
Secured Term Loans
A secured term loan is a loan granted to the business where the borrower then pledges some form of security or collateral against the loan. Our lenders look at either property (commercial or residential) or a debtors book as security against a loan. This means that your business cash flow and profitability is not as important as the underlying security offered to the lender. Because there is security, the risk is lower than an unsecured loan and so the interest rates charged by the lender are normally lower than an unsecured loan. Secured loans are normally short medium term loans ranging from 6 months to 5 years.