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Mary Driscoll, Senior Research Fellow from APQC

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  1. 1. Fortifying the Financial Close-to-Disclose Process AUTHOR Mary Driscoll Senior Research Fellow APQC October 2012 Research conducted by Research sponsored by
  2. 2. Situation Analysis A growing number of CFOs and finance directors are now turning their attention to the close-todisclose process, which involves all activities needed to close an organization’s accounting books, perform all necessary intercompany accounting and reconciliation steps, finalize consolidated financial statements and, finally, release earnings and publish official statements with regulators ranging from the Securities and Exchange Commission in the U.S. (SEC) to operators of securities markets in Europe and Asia. At many firms, this bastion of financial management (FM) has functioned in much the same way for decades. But change is underway. In the wake of the global financial crisis, pressure is mounting from internal and external stakeholders—especially investors, auditors, and securities regulators—for rock-solid assurances that accounting books and systems are of the highest integrity. That means no errors, faster reporting, process transparency, and agility in dealing with a torrent of new disclosure requirements. “Global markets are demanding greater detail on companies in shorter time scales,” said Pat Cleverly, Director of Research Policy, and Strategy at Tomorrow’s Company, a London-based research and agenda-setting firm. Her remarks came in a webinar following the publication of a landmark report on corporate reporting.1 “What is making a crucial process even more pressurized is the raft of new disclosure requirements coming out of the Financial Accounting Standards Board (FASB),” says George Wilson, vice president of The SEC Institute, a Miami-based conferences and training company that specializes in SEC reporting. There is heightened regulator interest in areas such as revenue recognition, operating leases, fair value, pensions, and derivatives, according to Wilson. And surely the pressure for more—and more meaningful—disclosures is felt on a global scale. The Chartered Institute of Management Accountants (CIMA), the world’s largest professional body of management accountants with members in 176 countries, reported in 2011 that over 90 percent of its members said disclosures are becoming more complex. Nick Topazio, a technical specialist at CIMA in London who focuses on external reporting, adds that the situation is exacerbated by the need for external reporting to be better aligned with internal reporting. The goal is bigger than satisfying the traditional needs of financial statement readers; the idea is to position companies to excel at integrated reporting. Integrated reporting refers to the integrated representation of a company’s performance in terms of both financial and non-financial results.2 It provides greater context for performance data, clarifies how sustainability fits into operations or a business, and helps embed sustainability into company decision making. CFOs and finance directors are also grumbling about new disclosure requirements they feel are vague. One example involves the presence (or not) of so-called conflict minerals that are 1 Tomorrow’s Corporate Reporting: A Critical System at Risk. Chartered Institute of Management Accountants (CIMA), PwC, and Tomorrow’s Company, 2011. 2 “Integrated Reporting.” Wikipedia, August 2012: K03956 ©2012 APQC ALL RIGHTS RESERVED Page 2
  3. 3. leveraged by perpetrators of violence in central Africa. The SEC wants organizations to reveal, in their own judgment, whether certain minerals exist in the products they manufacture or exist in components or raw materials procured across global supply chains. The rule is an outgrowth of the Dodd-Frank financial-system reform effort in the United States.3 One exasperated senior finance executive told APQC, “Conflict resources? OK, whatever that means! It’s difficult to implement disclosure requirements such as this.” CFOs Seeking Change The close-to-disclose process is not clearly visible to uninvolved managers, but it is an acute priority for CEOs, CFOs, and board-level audit committee members, all of whom bear public responsibility and potential personal legal liability in the event of process failure. White-collar crimes in the late-1990s prompted passage of the Sarbanes-Oxley law in 2002, and that led to stronger internal controls. Similarly, the current increase in regulatory scrutiny is motivating CFOs to review their close-to-disclose processes. In the first quarter of 2012, APQC conducted a survey on trends in FM process improvement. Responses were gathered from 145 senior finance executives from large United States and European organizations, with a small percentage coming from Asia. One surprising finding: nearly 75 percent of organizations reported that the close-to-disclose process ranked among their top-two targets for FM improvement over the next 18 months (Figure 1). Most Popular Targets for Financial Process Improvement Percentage Process 78% Plan, budget, forecast/analyze, re-plan 72% Close/consolidate/report 70% General accounting (any sub-process) 50% Accounts payable transaction management (any sub-process) 46% Working capital management Figure 1 3 Jessica Holzer. “Wal-Mart, Target Avoid Mining Rule: Big U.S. Retailers Are Expected to Escape Dodd-Frank 'Conflict Mineral' Disclosure Requirement.” The Wall Street Journal, August 2012: K03956 ©2012 APQC ALL RIGHTS RESERVED Page 3
  4. 4. The senior finance executives and subject matter experts interviewed for this report sounded a common theme: many large organizations, particularly those that have seen robust global expansion over the last decade, could stand to improve in one or all of the following four areas: 1. Take less time to gather and process financial data. Finance executives often complain that they have to spend too much time assembling, reconciling, and consolidating data, and there’s precious little time left at the end of the process for critical review. They desperately want more time to think through what the financial results say about underlying performance drivers. They want to prepare meaningful analyses for senior executives, board members, and external stakeholders. They want more time to fine-tune their approaches to investor-relations issues, get ready for the “earnings call,” etc. But an over-hang of data wrap-up work at the 11th hour gets in the way of process effectiveness. For many, delays in the so-called upstream processes come home to roost. For many, a big source of this problem has to do with the ungainly need to (a) take transaction data that had previously been pulled into the the general ledger by automated systems and (b) pour that data into manual processes for the final steps of close-to-disclose. What’s more, many large companies are burdened by the number of entities that have to be consolidated and the number of secondary systems that have to be tapped (e.g., treasury, tax, fixed assets, and non-FM databases such as those used in sales and marketing). An interesting perspective on this (Figures 2 and Figure 3) comes from Leinani Malig, president of Kauleo Consulting, and Trevor Gillespie, audit partner at Mohler, Nixon & Williams.4 4 APQC. “The Financial Close - Why Is It Still Such a Challenge?: June 2012 FM Community Call.” APQC Knowledge Base, June 2012. K03956 ©2012 APQC ALL RIGHTS RESERVED Page 4
  5. 5. Use of Multiple Systems Increases Complexity Figure 2 K03956 ©2012 APQC ALL RIGHTS RESERVED Page 5
  6. 6. Multiple Entities Drive Complexity Figure 3 2. Use automation to boost process effectiveness. One example comes from Kyle Cheney, a partner with Deloitte & Touche LLP. “An optimized reconciliation management system can introduce significant efficiencies while simultaneously mitigating risk of financial errors. I have been working with several of my clients to automate the reconciliation of a large portion of their balance sheet accounts, and the results are significant. They are saving time resulting from functionality that supports integrating balances from the general ledger and sub-systems, improving workflow approvals and document management. We are seeing up to 25 percent process-cost reduction coupled with increased confidence in the reported balances, which is a very compelling value proposition.” An interesting dimension to this: software solutions in this space have matured, and some have very compelling functionality around key process areas such as variance analysis, journal entry processing, and close scheduling. Given that global expansion has added to the close-to-disclose burden, more CFOs and finance directors of multinational organizations will no doubt want to automate more process steps. 3. Identify the root causes of accounting and reporting errors and reduce the risk of restatements. The specter of having to fix errors and restate financials that have been filed with regulators has grown more alarming. “The cost of improper accounting and reporting K03956 ©2012 APQC ALL RIGHTS RESERVED Page 6
  7. 7. has risen,” notes Jim Robertson, currently an independent consultant with 20+ years’ experience as a senior corporate finance executive. “In the past, the SEC would generally request a restatement of the current quarter and some prior quarters. But now, my sense is that restatements are being requested further back, often over years. And the sheer amount of work for a restatement is just so overwhelming today, given the growing reporting and disclosure requirements. CFOs and controllers are now more than ever intensely focused on getting the numbers right the first time. Small companies are at a singular disadvantage here because they tend to lack enabling consolidation systems and process rigor. But even some companies that have implemented an enterprise-wide ERP, or rely on a consolidation tool, continue to rely on Excel-based manual processes which remain sources of error. These are some of the issues that keep CFOs and controllers up at night,” says Robertson. Kyle Cheney concurs: “you need to take a hard look at specific process areas that have historically been labor-intensive and difficult to control. For example, intercompany accounting is often the most time-consuming aspect of the close for multinational companies. There is tremendous difficulty in reconciling, settling and clearing out intercompany transactions that cross borders, which often results in challenges in reporting gain/loss on multi-currency translation and excessive tax liabilities. Improving and automating intercompany accounting can certainly reduce financial reporting risk and tax liability while increasing process efficiency. This is an area that leading companies are looking at now.” CFOs and finance directors also want more transparency around the linkage between data coming out of core financial systems and data landing in the financial statements. According to Cheney, “you want to be sure there’s no breakdown as you’re pulling information from various sources. We see a growing use of technology to insert an automated auditing capability right into the reporting and disclosure process. That gives you assurance that, for example, a number that shows up in the disclosures is the same number that shows up on the face of the financials, and ties to the source data.” 4. Strengthen alignment between the data used for regulatory reporting and the data used for planning and resource allocation by internal P&L owners. The point is to improve the quality of information used by internal decision makers. A best practice in this regard is to embrace what’s called driver-based planning—and that requires that financial data and operational metrics are aligned in the context of performance reporting. Information quality, broken down in this sense, has equal parts of accuracy, freshness, consistency, and accessibility. APQC research indicates that more senior executives working today at large, complex organizations are asking for financial data governance models that ensure performance is accurately measured and tracked consistently across the enterprise. Such an ideal would tend to rule out a heavy reliance on manual data entry and spreadsheets during the close-to-disclose process. K03956 ©2012 APQC ALL RIGHTS RESERVED Page 7
  8. 8. The Relative Cost and Speed of Close-toDisclose When it comes to assembling the business case for investing in close-to-disclose improvement, CFOs and finance directors are looking very closely at the return-on-investment arithmetic. And well they should. According to data from APQC’s Open Standards Benchmarking in general accounting and reporting, there is a direct correlation between (a) the total cost to perform financial reporting per $1,000 in revenue and (b) the speed with which an organization completes the close-to-disclose cycle.5 First, consider the cost of producing and filing SEC Form 10-Q.6 The fastest companies—those that prepare and file their quarterly statements in 10 or fewer days—reside in the top quartile and spend relatively less money to perform financial reporting per $1,000 in revenue (Figure 4).7 Obviously, the slowest organizations—those that take more than 25 days to complete the quartertly cycle and comprise the bottom quartile—are at a disadvantage. Total Cost to Perform Quarterly Financial Reporting per $1,000 Revenue $1.20 $1.06 $1.00 $0.80 $0.67 $0.60 $0.42 $0.40 $0.33 $0.20 $0.00 $0.22 $0.10 The Fastest: Quarterly Cycle Time N = 49 Top Quartile Median The Slowest: Quarterly Cycle Time N = 42 Bottom Quartile Figure 4 5 APQC defines perform financial reporting as the process of compiling financial data, developing corporate or business unit financial reports for management and board review, preparing consolidated financial statements for public release, and filing official documents with regulators as required by law. 6 A 10-Q is a comprehensive report of a company's performance that must be submitted quarterly by all public companies to the Securities and Exchange Commission. Its annual counterpart is SEC Form 10-K. 7 The top quartile is the performance level above which 25% of all responses occur. The bottom quartile is the performance level above which 75% of all responses occur. The median is the middle value in a set of values that are arranged in ascending or descending order. K03956 ©2012 APQC ALL RIGHTS RESERVED Page 8
  9. 9. As shown in Figure 5 on the next page, a similar difference exists between organizations that are the fastest when it comes to completeing the annual close-to-disclose cycle (15 or fewer days) and the slowest (37 or more days). Total Cost to Perform Annual Financial Reporting per $1,000 Revenue $1.00 $0.90 $0.80 $0.70 $0.60 $0.50 $0.40 $0.30 $0.20 $0.10 $0.00 $0.96 $0.69 $0.41 $0.23 $0.21 $0.09 The Fastest: Annual Cycle Time N = 51 Top Quartile Median The Slowest: Annual Cycle Time N = 41 Bottom Quartile Figure 5 Another view of performance in this space is to look simply at relative close-to-disclose cycle times (Figure 6 and Figure 7). For this view, APQC gathered the performance of just over 200 organizations and sorted them into quartiles. K03956 ©2012 APQC ALL RIGHTS RESERVED Page 9
  10. 10. Cycle Time in Days between Completion of Quarterly Consolidated Financial Statements and the Release of Earnings 30 25 25 20 18 15 10 10 5 0 Top Performers Median Bottom Performers N = 209 Figure 6 Cycle Time in Days between Completion of Annual Consolidated Financial Statements and the Release of Earnings 40 36 35 30 25 25 20 15 15 10 5 0 Top Performers Median Bottom Performers N = 210 Figure 7 K03956 ©2012 APQC ALL RIGHTS RESERVED Page 10
  11. 11. The Need for a Holistic Approach Although it’s tempting to fixate on the linkages between speed and cost, it is important to keep in mind the need to establish a well-designed process and a sound control environment that provides top-quality financial reporting to both internal users—the C-suite, the executive board, and business unit managers—and external users of official financial statements. What’s involved? The Gartner Group suggests that “financial governance solutions [serve] as a missing link between corporate performance management (CPM) and governance risk, and compliance (GRC) solutions, particularly in the final stages before disclosure (a.k.a. the last mile of finance). While ERP-based tools can help guide the financial close process, they typically do not encompass the post-GL close process, which includes all the financial consolidation activities needed to create external financial statements and regulatory reporting. Despite the breadth of functionality in CPM and ERP systems, they don’t go far enough in providing a holistic approach to the activities that are required to complete the financial close.”8 A concurring opinion from Deloitte says that the risk of error and restatement is best mitigated by “a holistic approach that understands how people, processes, and systems—both individually and collectively—may help an organization improve the efficiency, governance, and quality of their reporting…[that is how] a finance organization can become a key strategic contributor the company’s success.”9 Meanwhile, APQC’s Open Standards Benchmarking shows the value of automating post-close financial processes. As shown in Figure 8, the top performers automate more than 93 percent of their journal entries (7.2 percent are manually processed) while the laggards automate 43 percent of theirs (57.3 percent are manually processed). And as shown in Figure 9, the laggards consequently spend nearly 12 times more to get the job done (45 cents versus $5.28). John E. Van Decker, an analyst at Gartner Group has observed: “CFOs who invest in the last mile of finance stand to reduce the cost of these processes by up to 30 percent, while also reducing the risk to company reputation and stock price associated with restatements.” 8 9 Van Decker, John E., “CFO Advisory: Last Mile of Finance Overview.” Gartner Group, April 2012. “The Last Mile of Finance: Strategically Transforming Financial Governance.” Deloitte Development LLC., 2012. K03956 ©2012 APQC ALL RIGHTS RESERVED Page 11
  12. 12. Percentage of Journal Entries Processed Manually 57.0% 60.0% 50.0% 40.0% 30.0% 25.0% 20.0% 10.0% 7.2% 0.0% Top Performers Median Bottom Performers N = 341 Figure 8 Total Cost to Perform General Accounting per Journal Entry Line Item $6.00 $5.28 $5.00 $4.00 $3.00 $2.03 $2.00 $1.00 $0.45 $0.00 Top Performers Median Bottom Performers N = 264 Figure 9 K03956 ©2012 APQC ALL RIGHTS RESERVED Page 12
  13. 13. Summary The close-to-disclose process will continue to grow more burdensome as will the pressure on the reporting staff. While more speed and less cost are indeed compelling targets for repair, these goals should not be pursued without a step back and a good look at the bigger picture. Finance must ensure excellence in corporate reporting on all levels. One must keep in mind the purpose of reporting: to assist in the effective functioning of the market economy by enabling shareholders, investors, and other stakeholders to assess the overall performance of a business and to establish its current and future value (CIMA, PwC, and Tomorrow’s Company). This core mission falls apart if shareholders and other stakeholders cannot rely on the quality of the information produced. Copyright ©2012 APQC, 123 North Post Oak Lane, Third Floor, Houston, Texas 77024‐7797 USA All terms such as company and product names appearing in this work may be trademarks or registered trademarks of their respective owners. This report cannot by reproduced or transmitted in any form or by any means electronic or mechanical, including photocopying, faxing, recording, or information storage and retrieval. K03956 ©2012 APQC ALL RIGHTS RESERVED Page 13