The CPA exam's business environment and concepts (BEC) test covers several areas that deal with business decisions. You must be able to consider the financial impact of extending credit to customers, go over the decision criteria for a special order, and see a series of formulas that help a manager decide on long-term capital spending and investment.
A key concept that each manager must understand is his firm’s business cycle. A business cycle starts when a company spends money to make a product or deliver a service. The product or service is delivered to the customer, and the customer pays the company. When the firm receives customer payments, the cycle starts over again.
A competent manager needs to know how long it takes for the cycle to be completed. Here are two reasons why:
Planning production: If you know how long it takes to manufacture and sell a product, you have some idea of when your inventory will run out. You can use that knowledge to plan more production to replenish your inventory levels. After all, you can’t sell more product if your shelves are empty.
Cash flow management: Understanding the cycle of spending, production, sales, and cash collections allows a manager to maintain a sufficient cash balance. The key here is that a business needs enough cash available to operate while waiting for other sales to be paid. If a business requires $30,000 a month to operate, management must plan for that cash need, based on the firm’s business cycle.
Say you manage Close Cut Lawn Mowers, a manufacturer of mowers. You sell mowers to home improvement stores and hardware stores. Since your clients need mowers for their customers in the spring, you forecast sales of 50,000 mowers in February and March. Your customers typically pay in 30 days. That means that the February and March sales are paid in March and April, respectively.
As a manager, you need to plan for heavy spending on materials and labor in December and January to produce mowers for February and March. You also need to plan the cash needed to meet the heavy production schedule. That’s how a manager uses the business cycle to plan production, sales, and cash management.