Three Tests Of Your Financial Reporting

There are three tests we look at with financials. How do your financials stack up?

Accuracy

Have you ever been on a trip and thought you were making good time, then realized that you were on the wrong road?

That can happen too in business. A CEO can think things are going well for the business, only later to find out that results were misreported and they were not doing as well as they thought.

Bad things happen to good people when the numbers are off. It doesn't have to be fraud. It could just be poor financial systems that don't pull in accurate financial data. It can also be just poor accounting policies that don't fit the industry or how the business operates.

Here are just a few examples of how we got numbers in better shape and led to better things happening in the business:

• For a pharmaceutical firm, we found that the cost accounting system was based on rosy-eyed forecasts on volume that could never be achieved. Rather than writing off the unabsorbed manufacturing costs, these were capitalized on the balance sheet each month, expecting that sales and production levels would pick up. Eventually, they had a bloated number for inventory. We came in and got the inventory accounting adjusted to a realistic level. We later revamped the entire cost accounting standards, so that the president could finally have confidence in product costs. This led to better quoting and being more competitive on lines that made money, while fading away from lines that were losing money. With more accurate numbers, we were able to work on a number of turnaround moves and convince the bank and venture capitalists to do another round of financing, leading to profits as much as 56% of sales in one year.
• For a consumer products firm, we strengthened their accruals, which had tended to be more on a cash basis and understated some costs. We also improved their cost accounting. With more up to date numbers in hand, we were then able to help them work on improving their operation which became profitable in the next year.
• For an association, we found that they had reported on a cash basis, even though member dues were on an annual basis tied to their anniversary date. This meant that revenue was recognized prematurely. Even though the board thought they were being fiscally responsible and running the association on a breakeven basis, in reality they were spending more than they should have each year had the revenues been recognized over time.
• For a young, rapidly growing company, we got the accrued expenses and balance sheet in line, so that expenses were reported timely. We also got inter-company transactions properly recognized. This helped give the bank the confidence to offer a line of credit.

Finally, a few comments on our financial reporting philosophy:

• Cash flow is king/queen. You can't fool around with this number.
• We believe in a balance sheet approach. Get the balance sheet right and your numbers can be right going forward. Have the balance sheet wrong and there is no way the numbers will be right. We take a hard look at the balance sheet and know the questions to ask.
• Get the numbers right and move on to improving the business. Don't mix the two. Don't make the accounting department try to generate income. That's the job of running the business. If there is a lump to take, get it done and move forward.

Timeliness

The numbers also need to be timely. Think of numbers as perishable data. The longer it takes for numbers to come out, the less value those numbers can have. If you are already deep into the next month, the less you care about last month's results. It would be like not finding out your score in golf on the front nine until the 15th hole. By that time, you are thinking more about the back nine. It is too late to make changes that could have affected your score on holes 10-14.

• We are strong lovers of the quick close for the financials. We feel that results should be reported within days of the month end. As CFO for a pharmaceutical manufacturer, we changed them from being over a month behind in their numbers to being the first firm to report numbers each month to the venture capitalists, usually 4 business days or sooner after month end.
• We take a look at all the steps in the month end reporting process, then lay out a new plan based on a fast financial close. We determine what needs to be done when, what data is needed at that time and who is responsible.
• We evaluate what level of precision is needed. We often find there are some numbers that are highly predictable and could be estimated ahead very close to what the final numbers would be. Rather than holding up the show for precision that won't make a material difference, if any, we develop a process to do an estimate and then true up the minor difference versus actual in the following month.
• We make sure that the financial systems and people are set to provide the information needed on a the faster timeline. We hit the bottlenecks hard.
• We also consider the value of a flash report right at month end. At the pharmaceutical firm, we knew what the actual results would be within 5% by the first morning after month end. We got the flash report out to everyone on the reporting package, then used the next couple days to finalize the numbers. This took some heat off of accounting (i.e. when will we have numbers?), since management knew what the results would be within reason ASAP after month end.

There is another important benefit to getting the numbers out sooner. Say you cut a week out of the financial reporting process. That gives the finance area one more week in the month to work on adding value to the current month, rather than reporting the past month.

Understandable

Finally, the numbers need to be communicated in a way that people can understand. How long does it take someone to figure out how the company did? Does the reporting package resemble an encyclopedia that nobody gets through?

• More is less. We have run into some thick reporting packages at some clients. People only have so much time. We cut the package down to a more manageable level.
• Summary. Often we find that there is not a good summary. We love the one page summary, with the key data reported right on the sheet. Even if this is all that your reader sees, they can get the gist of how you did.
• Non financial metrics. Some financial reporting packages are very accounting driven. That misses an opportunity. There could be non financial measures that really tell a lot too. We work with management to see what other metrics ought to be included. What tells you whether your business has done well or not? It should be there in your package.
• Charts. A picture can tell a 1,000 words. A few good charts can go a long way to get your results across. It can also be different strokes for different folks. Some people get it better from numbers, others get it better from charts. We see about including some key charts to cover the latter people. Another advantage of charts- you can show correlations that can't show up easily from straight numbers alone.
• Visual. In addition to charts, we consider the overall visual layout of the package. What is the reader likely to see? Is too much crammed in? How easily can a reader find their way around the package?