These specimen terms of reference are for guidance only and are based on the example published in the Smith Report (see 1.138 above). Terms of reference should be developed and adapted to suit the specific circumstances of the com- pany or group.
1 Constitution
1.1 The board hereby resolves to establish a committee of the board, to be known as the audit committee (‘the committee’).
2 Membership
2.1 The committee shall be appointed by the board. All members of the com- mittee shall be independent non-executive directors of the company. The committee shall consist of not less than three members. Two members shall comprise a quorum at any meeting of the committee.
2.2 The chairman of the committee shall be appointed by the board from amongst the independent non-executive directors.
3 Attendance at Meetings
3.1 The finance director, the head of internal audit and a representative of the external auditors shall attend meetings at the invitation of the committee.
3.2 The chairman of the board and other board members shall attend meet- ings if invited by the committee.
3.3 There shall be at least one committee meeting, or part of a meeting, each year where the external auditors and internal auditors attend without management present.
3.4 The company secretary shall be the secretary to the committee.
4 Frequency of Meetings
4.1 Meetings shall be held not less than three times each year and, where appropriate, shall coincide with key dates in the company’s financial reporting cycle.
4.2 Additional meetings shall be held as required, and the external auditors or internal auditors may request a meeting if they consider that one is necessary.
5 Authority
5.1 The committee is authorised by the board to:
investigate any activity within its terms of reference;
seek any information that it requires from any employee (and all employ- ees are directed to co-operate with any request made by the committee);
and
obtain external legal or other independent professional advice and request advisers to attend meetings as necessary.
6 Responsibilities
6.1 The responsibilities of the committee shall be:
to consider the appointment of the external auditor and assess the inde- pendence of the external auditor, ensuring that key partners are rotated at appropriate intervals;
to oversee the process for selecting the external auditor and make appropriate recommendations, through the board, to the shareholders for consideration at the AGM;
to recommend the audit fee to the board and pre-approve any fees in respect of non-audit service provided by the external auditor, and to ensure that the provision of non-audit services does not impair the independence or objectivity of the external auditor;
to discuss with the external auditor, before the audit commences, the nature and scope of the audit, and any additional assurance or report- ing that may be required, and to review the auditor’s quality control procedures and the steps taken to respond to changes in regulatory and other requirements;
to consider whether there is appropriate liaison and co-ordination between the internal and external auditors;
to review the external auditor’s management letter and management’s response;
to review the internal audit programme and ensure that the internal audit function is adequately resourced and has appropriate standing within the company;
to consider management’s response to any major internal audit or exter- nal audit recommendations;
to approve the appointment or dismissal of the head of internal audit;
to review the company’s procedures for handling allegations from whistleblowers;
to review reports from management and the internal auditors on the effectiveness of the systems for internal financial control, financial reporting and risk management.
Audit
to review, and challenge where necessary, the actions and judgements of management in relation to the interim report, annual financial state- ments and other formal reports on the company’s financial performance before submission to the board, paying particular attention to:
critical accounting policies and practices and any changes in them,
decisions requiring a major element of judgement,
the extent to which the financial statements are affected by any unusual transactions in the year, and how they are disclosed,
the clarity of disclosures,
significant adjustments resulting from the audit,
the going concern assumption,
compliance with accounting standards, and
compliance with stock exchange and other legal requirements;
to review the company’s statements on compliance with the Combined Code, going concern and the review of the effectiveness of the company’s system of internal control prior to endorsement by the board, and in par- ticular to review:
the policies and processes for identifying and assessing business risks and the management of those risks by the company,
the company’s policies for ensuring compliance with relevant legal and regulatory requirements,
the company’s policies for the prevention and detection of fraud, and
the effectiveness of such policies and procedures in practice;
to discuss any problems and reservations arising from the external audit and any matters that the external and internal auditors may wish to discuss (in the absence of management where necessary);
to consider other topics and issues, as defined by the board.
7 Reporting Procedures
7.1 The secretary shall circulate the minutes of meetings of the committee to all members of the board.
7.2 The chairman of the committee, or as a minimum another member of the committee, shall attend the board meeting at which the annual accounts and reports are approved.
7.3 The committee’s responsibilities and activities during the year shall be disclosed in the annual report and accounts.
7.4 The chairman of the committee shall attend the AGM and answer ques- tions, through the chairman of the board, on the committee’s responsibil- ities and activities.
8 Terms of Reference
8.1 The committee shall conduct an annual review of its terms of reference and make recommendations to the board.
Cashflow Management
Cashflow Management
2.1 Overview
2.5 Managing Cash Resources 2.17 Managing Debtors
2.28 Managing Creditors 2.34 Managing Stock
Appendix 1 Useful Websites on Cashflow Management and Related Issues
2
Cashflow Management
2.1 Overview
2 Cashflow Management
At a Glance
* Business growth always puts pressure on cashflow, but careful manage- ment can help to minimise working capital requirements.
* The objective of managing working capital is to ensure that sufficient funds are available to meet the day-to-day cashflow needs of the business.
* There are a number of common weaknesses that need to be addressed when managing working capital.
2.2 Importance of Cashflow Management
In developing any business, it is important to appreciate the relationship between growth and cashflow. A company’s trading performance controls the amount of cash that flows in and out of the business, but the rate at which that cashflow takes place depends on the efficiency with which the company’s assets and liabilities are managed. Business growth always puts pressure on cash resources because of the inevitable delays between the timing of payments (cash outflow) and receipts (cash inflow). Good management of cash, debtors, cred- itors and stock helps to minimise working capital requirements and either reduces borrowing costs or releases funds for other profitable investment. Even the most profitable of companies can fail if its cashflow is not properly managed.
2.3 Managing Working Capital
The main objective of working capital management is to ensure that sufficient cash is available to meet the day-to-day cashflow needs of the business. These will include making payments on time to:
management and staff, in the form of wages and salaries;
those who supply goods and services to the company;
central and local government, in the form of VAT, corporation tax, business rates etc.
In order to manage working capital and cashflow effectively, management needs to have regular and reliable information on what is happening in every aspect of the business.
2.4 Common Weaknesses
The more common weaknesses in managing a company’s working capital requirements include:
failure to prepare cashflow forecasts, or to use and update them on a regular basis once they have been prepared – this usually results in the business encountering regular cash crises and relying heavily on expensive short-term borrowings;
failure to budget in terms of the balance sheet as well as the profit and loss account – without this, there is no benchmark against which to measure the effectiveness of the company’s asset management;
failure to control debtors effectively, thus missing the best opportunity for releasing working capital for other purposes;
attempts to increase cash resources by not paying suppliers, without consider- ing the damage that this might do to relationships and the consequent effect on supplies or other aspects of the company’s business;
failure to appreciate the true cost of holding unnecessarily high levels of stock.
2.5 Managing Cash Resources
At a Glance
* A detailed medium-term cashflow forecast should be prepared to identify when surplus cash is likely to arise and when additional cash is likely to be required.
* This requires the preparation of realistic monthly forecasts for all items of income and expenditure for a period of at least twelve months.
* Assumptions made in preparing the forecast should be consistent and clearly thought through, and should be documented for future reference.
* It is helpful to incorporate a measure of sensitivity into the forecast, so that the potential effect of unexpected events can be assessed.
* Prompt action should be taken to deal with any potential cash shortages identified by the forecast.
* Actual cashflow should be compared with the forecast on a regular basis (usually monthly).
* Bank charges should be subjected to regular monitoring and review.
* Guidelines should be established for the investment of surplus funds as they arise.
* Controls should be established to achieve an acceptable degree of secur- ity over the company’s cash resources.
2.6 Key Aspects
The key aspects of the management of cash resources are:
regular preparation and updating of cashflow forecasts;
regular monitoring of cash balances;
prompt investment of surplus funds; and
development of good internal control over cash.
2.7 Need for Cashflow Forecasts
Every business will need to prepare short-term cashflow forecasts (eg an infor- mal projection of the cash requirements over the next week) to confirm that the immediate cash needs can be met from existing resources or facilities, but in order to manage cash resources effectively a more detailed, medium-term fore- cast will need to be developed. The objective is to identify:
when surplus cash is likely to arise, so that returns on this can be maximised; and
when additional cash is likely to be required, so that appropriate borrowings can be arranged at the lowest available cost – bank overdrafts are usually one of the most expensive forms of borrowing, so if the cashflow forecast indi- cates a longer-term need for a particular level of finance, it will be advisable to try to arrange a cheaper alternative.
The completed forecast will provide a useful benchmark against which to measure actual cashflow performance. A detailed cashflow forecast will also be an important element of the information that the directors need in order to assess whether the business is a going concern (see 6CORPORATE GOVERNANCEand 11FINANCIAL REPORTING).
2.8 Preparing a Detailed Cashflow Forecast
The preparation of a detailed medium-term cashflow forecast will involve the collation of information from a variety of sources within the business. In par- ticular, it will require the preparation of sensible monthly forecasts of all items of income and expenditure, based on projections of:
sales;
other income (eg investment income);
staff wages and salaries;
other direct costs and overheads;
fixed asset purchases and disposals;
financing charges;
taxation, including VAT; and
any other payments that the business is committed to making (eg repayment of loan finance).
Cashflow Management
These projections must take into account the expected timing of the related cashflows. For instance, in the case of sales, as well as predicting the total amount of goods or services to be sold over the period, it will also be necessary to assess when the company’s customers will actually pay for the goods and services that they have received, taking into account the company’s standard payment terms and also past experience of business with those customers. The projections should cover a minimum period of twelve months. Depending on the nature of the business it may be possible or advisable to prepare cashflow forecasts for a longer period. Another useful option is to prepare the forecast on a rolling basis, so that projections for an additional period are added on a monthly or quarterly basis as appropriate and the detailed forecast always looks ahead for a period of twelve months. An example layout of a detailed cashflow forecast is given overleaf.
2.9 Assumptions
The preparation of a cashflow forecast will inevitably involve the use of assump- tions. These should be clearly thought through and documented for future refer- ence. It is also of critical importance that the assumptions used in different aspects of the forecast are consistent with one another – for instance, that the projections for direct costs are based on the same sales volumes as the sales projections.
2.10 Sensitivity Analysis
It is usually helpful to incorporate a measure of sensitivity into the cashflow forecast. For instance, what will happen to the overall cash position if a signifi- cant order fails to materialise as predicted, or if a customer suddenly doubles his order requirements (with a consequent effect on direct costs, which may need to be paid before the additional income comes in from the increased sales)?
Will there be sufficient flexibility in the available cash resources to cope with this? It is also important to consider the impact that fixed overhead costs will have on cashflow if the predicted sales income is not achieved or is achieved later than originally expected.
2.11 Using a Cashflow Forecast
Having put time and effort into preparing a cashflow forecast, it is vital that the end result is put to good use. If the forecast indicates a serious cash shortage at certain times of the year, the first step is to consider whether some of the projected expenditure could be rescheduled – for instance, delaying the purchase of some fixed assets for a month or two may avoid the cash shortage without ser- ious detriment to the business operations. Inevitably, many payments cannot be delayed and if it is not possible to avoid the cash shortage by rescheduling expenditure, the options for obtaining some additional finance should be explored at an early stage.
Chapter 2 – Cashflow Management95
Cashflow Management
Sales
Investment income Loans received Other
Total receipts Payments Wages and salaries PAYE and NI Direct costs:
Materials Power etc.
Overheads Insurance Travel Rates Leasing Bank charges etc.
Fixed assets VAT
Loan repayments Corporation tax
Total payments
Surplus/(deficit) for month Opening bank balance Closing bank balance
2.12 Regular Comparison of Actual with Forecast
Actual cashflows should be compared with the forecast on a regular basis (usu- ally monthly) and any significant variations should be investigated, so that remed- ial action can be taken if necessary. This exercise involves comparing actual receipts and payments against the original forecast, so that differences can be identified and explained. The forecast for the remainder of the period should then be updated to reflect the impact of any receipts and payments that were projected to arise at an earlier date but which are still outstanding. The overall projected cash position will need to be checked again to confirm that it is still within the facilities available, or to identify when additional arrangements will need to be put into place. These steps should help management to con- stantly refine and improve their forecasting procedures, and also help to clarify exactly what is happening within the business.
2.13 Relationship with Bank
If the updated forecast indicates that an agreed overdraft limit is likely to be breached for a short time, this should be discussed with the bank manager at the earliest opportunity. If the forecast indicates that the present overdraft limit is likely to be inadequate in the longer term, further action will be needed, either to obtain additional finance from other sources or to approach the bank for an increase in the overdraft. A business is more likely to get a positive response from the bank if it can demonstrate that it has working capital, and in particular cash- flow, under good control than if it gives the impression of living from day to day and dealing with the surprises as they happen. Regular communication with the bank when things are going well will put useful relationships in place for the time when additional help and support is needed.
2.14 Monitoring Bank Balances
As well as keeping a regular check on cashflows, and comparing actual with forecast, it is also important to be aware of the current bank position and in par- ticular to understand exactly what the bank is charging the business for the facilities that it provides. Issues to be considered include the following.
Do you understand the extent and implications of the various elements of the charges that the bank makes and when these will be charged to your account?
Do you understand the interest arrangements in respect of the account?
Do you predict what the charges will be, compare this with the amount actu- ally charged and immediately follow up any apparent overcharging?
Smaller businesses in particular, and especially those that are new and growing, are often in a difficult position when it comes to negotiating with their bankers,
but it is advisable to try to ensure that terms are reviewed on a regular basis and that the bank is offering the best deal available.
2.15 Investment of Surplus Funds
Guidelines should be established in advance for the investment of surplus funds as they arise – leaving money idle in a bank account costs the business money in terms of lost income. There will usually be a cost to transferring sur- plus funds to a deposit or money market account and it is therefore important to establish that the return will be worthwhile. It should be relatively straight- forward to establish the minimum amount that needs to be invested in order to achieve a return and thus to set a sensible guideline above which funds should be considered for investment. The period of time for which the funds can be invested will depend on the company’s financial commitments. An up-to-date cashflow forecast should be helpful in establishing when the surplus funds will need to be available for other purposes.
2.16 Internal Controls Over Cash
Controls should be established to achieve a sensible degree of security over the company’s cash and to ensure that receipts and payments are recorded promptly in the accounting records. In a more complex organisation, and particularly where extensive use is made of electronic payments and receipts, additional con- trols may need to be introduced. Basic cash controls will usually include proced- ures to ensure that:
duties in this area are segregated as far as is practicable;
all payments are supported by appropriately authorised documentation, which should be presented to the person signing the cheque (or equivalent);
all receipts are banked at the earliest practical opportunity;
any amounts received in cash are banked in tact (ie some or all of the cash is not used for other business purposes);
detailed reconciliations are prepared monthly (at least) for each bank account and are subject to regular review – and any unusual, or long outstanding, items are promptly investigated.
In particular, staff should be made aware of the need to bank funds promptly.
In a smaller operation it may be appropriate for banking to take place once or twice a week as a general rule, but in a larger company daily bankings will usu- ally be needed. Even where banking takes place only on set days, special arrangements should be made to ensure that large cheques are banked as soon as they are received rather than being held until the next regular banking.
Customers should also be encouraged to make use of bank transfers and other electronic payment methods as much as possible, as this speeds up the process of cleared funds reaching the company’s bank account.
Cashflow Management