Wednesday 30 May 2007

Penny Differences

Rounding errors can be the bane of an accounting system. What do I mean?

  • A client called to say that foreign exchange gain / loss calculations were leaving a penny in his accounts receivable invoices when payments were applied. I wasn't too worried about it until he showed me his receivables report: pages and pages of penny after penny. [Mental note: when a client is concerned enough to call, take them seriously!]
  • A charity client gets 50% of GST back so we split the then 7% GST into a 3.5% expensed tax and a 3.5% refundable tax. With rounding to the penny, there were frequently penny differences between our calculation and the vendor invoices, which just did the 7% calculation.
Problems like this are a thorn in the side of the data entry staff. They create unnecessary work and are just plain frustrating.

What can be done? Maybe nothing. It may be that you don't have the ability to change the software to correct the problem, so you have to devise a work around, like a utility that periodically sweeps the tables and deals with penny differences. In any event, early detection is key to minimizing the problem.

Start with proper system testing. There is a tendency to test the system with invoices of $1,000 or some equally round number. That can hide rounding issues. Instead, take a stack of at least 20 copies of real invoices and credit notes and enter them exactly as they came. That will make your testing more realistic and is more likely to flush out issues.

If you can influence the process, avoid having the same calculation performed more than once. For example, a company had an invoicing module that was independent of its accounting system. When the invoices were imported, the accounting system recalculated the taxes, resulting in rounding differences. To avoid penny differences, the invoices should have been imported without recalculation.

Finally, ensure that the same algorithm is used throughout, so that one system doesn't round down while the other rounds up.

Penny for your thoughts . . .

Sunday 27 May 2007

Good News or Bad News

Have you ever read an accounting analysis that sounded something like this:

The negative variance this month is due in part to budgetary timing differences offset by expense accruals . . .
Is that news good or bad? Who knows? What's clear is that accounting jargon is distorting the message. Now, most analysis doesn't get quite this bad, but jargon is a big issue in financial statement analysis. Here's a little primer:

Variance - the difference between two numbers, e.g. this year and last year or this year and budget. A positive variance is good. A negative variance is bad.

Timing Difference - typically means that an expense was expected but it occurred in a different month (either earlier or later) than originally forecast. This is neither good nor bad news. It just explains why the number is different.

Accruals - see below for a more detailed description. Accruals mean you recognize your income when you earn it, not when the money comes in and you record your expense when you owe the money or have used the good/service, not when the money is actually paid.

For me the biggest issue with financial analysis is not the jargon, however, it's the tendency to say what happened, but not why. Decision makers need to know things are going right (or wrong) in order to make good decisions. Knowing that an expense went over budget is only half the battle. You need to know why as well.

Accruals

I first was promoted to Controller during a shakeout at an insurance brokerage which went right to the top. After a couple of months, the new president called me into his office to explain why "my" sales number was different than his. He was trying to understand the financial statements and he had copied all of the invoices issued to customers in the month. I explained that some of our policies went for more than one year and we had to wait until we earned the commission in the future years before we could include the money in our sales numbers. It made sense to him. It also helped de-mystify the whole accounting process for him.

But I think the final word has to go to the Vice-President who cured me of my accounting financial analysis jargon. He said to me, "Bill, from now on I want to see the words, 'Good News', or 'Bad News' at the top of your analysis reports."

That's what it all comes down to, isn't it?

Re-Energizing an Old System - Reporting

Businesses transform, sometimes daily. Accounting systems evolve.

How do you know whether your accounting system has fallen behind the business?

Reporting

  1. Ask people if they use their reports.
    A client of mine acquired a small business in northern Ontario. They asked me to go in and review the accounting system. I worked with the local Controller and asked him if I could interview the General Manager, so we made an appointment. I asked her what she thought of the financial statements and her reply was classic, "Oh, I don't use them. Too many numbers." It was true. The accounting report was on legal landscape paper with a column for everything you could think of. All the information was there, but you had to analyze carefully to find it. The Controller was crushed. He had worked so hard to get everything into one report. Later he said to me, "If she had only told me, I would have given her what she wanted."
  2. Don't wait for them to ask for new ones.
    They often assume that what they are getting are the only reports available.
  3. Don't just accept what they say.
    Sometimes even when you ask they are not forthcoming or can even be hostile. I asked a production manager what would help him schedule jobs for the tool and die shop. His first answer was, "There's no way you're replacing me with a computer." That night I used a spreadsheet to make a mock version of the kind of report I had in mind. When I showed it to him the next day, he tore it apart. Why did I use the shop number? Customers always call using their P.O. number, etc. etc. But we had moved from discussing whether he needed a report to just what report would help. Eventually we found what he needed, and no, he was never replaced by a computer!
Reporting is the key because it supports good decision making. It's not just the reports, but also how they are formatted and how quickly they are produced.

Sunday 20 May 2007

Accounting vs. Operations

Accounting versus Operations? Shouldn't the Accounting Department support Operations?

Absolutely.

But sometimes, accounting results can lead to the wrong operational decisions. Let me give you a couple of examples:

  • A client of mine sold high grade tool steel in pre-cut sizes. If a customer ordered an eight inch round (for example) and they didn't have any in stock, they would take the next higher size (e.g. nine inch) and cut it down. All of the profit for that sale ended up as scrap on the floor, but at least the customer relationship was preserved. The problem came when they ordered more steel because the accounting system recorded it as a sale of the nine inch size which meant that nine inch would be reordered instead of what the customer wanted.

  • Another major issue is sales between divisions. The easiest way to track these sales is to sell at cost. That way there is no profit recognized on what is really an internal transfer. But how does that effect the profit shown by the two divisions? If the bonuses of the division managers are based on division profit, selling at cost may not reflect the economic results of the two. Selling at cost also removes any incentive to the producing division to be efficient. The correct response: let the two division managers negotiate a fair price. Additional entries may be necessary at year end, but the operational results will be much better.
Accounting must serve Operations, not the other way around!

Thursday 17 May 2007

Eliminate M.E.S.S.


M.E.S.S. stands for Manually Entered SpreadSheets. Don't get me wrong. I was raised on spreadsheets: first Visicalc, then Lotus 123, finally Excel. They are a second language to me. But when I see people pecking away entering raw data in them, I have to wonder why they can't get it from their accounting system. Ideally, their time should be spent analyzing their data, not keying it in.

Why does M.E.S.S. happen?

  • A lack of trust in the accounting system, particularly when someone was not in favour of the change to begin with. Early in my career, a mining client converted their accounting system. The Accounts Payable manager, close to retirement, didn't trust the new computer, so she kept track of all of her vendors using a spreadsheet. About a month after going live, the new system crashed. They were forced to recreate the information manually. Everyone that is, except Accounts Payable. Guess who felt completely vindicated?

  • The accounting system does not allow for all requirements. A government agency I worked with had a large number of "sidecar systems", meaning M.E.S.S. The reason was that their accounting system didn't track the information they needed. The spreadsheets were so ingrained in the system that when we converted to new software many people didn't think to include them in their requirements. The implementation team had to actually root them out and convince people that they were no longer necessary.

  • Insufficient detail in the General Ledger. At one client it was someone's job to take all of the entries in the Employee Advances account and separate them by employee in a spreadsheet, so that the individual advances could be tracked. The General Ledger needed to have an account (or subaccount) for each employee so that time wouldn't be wasted making the entries twice.
Is M.E.S.S. ever justified? Of course if you are doing something that has never been done before, like due diligence on the purchase of a company, then you have no choice. The issue for me is when the same spreadsheet is prepared month after month. Then, it's a M.E.S.S.!

Wednesday 16 May 2007

Getting to Phase II

Remember when you first installed your accounting system? Remember how the implementation team wisely left the "nice to haves" out of the project as they wrestled with customization, training and data conversion issues? How many times did you hear, "Let's leave that to Phase II"?

Did Phase II ever happen? If you just answered YES, then congratulations! Many systems never make it that far.

What am I talking about?

  • The digital dashboard that was going to show all your key performance indicators automatically, all in one place.
  • The customized financial reporting that was going to put the power in the hands of the end users.
  • The add-on software tailored to your unique industry.
  • The automated integration which your system currently handles manually.
  • The cool new software that would make sales analysis a snap.
So what happens?
  • Software and data issues chew up the budget for the whole project.
  • Delays push the project up to its deadlines.
  • The project team goes on to other projects.
  • People put in so much overtime that they lose their energy.
The result is an accounting system that processes transactions and reports results, but is missing those things that made it so attractive to begin with.

My message to you is: Don't abandon your dream!

Go back to the original plan. Be both cheerleader and slave driver, but get it back on track. This blog is devoted to getting the most out of business systems. Don't settle for less than the best!