Financial reporting, the strategic organizational challenge

Why does an organization need financial systems? What is the basic deliverable, and how does current technology lend itself to meeting those needs. This article discusses the strategic challenge corporations face with regard to their financial information, and how most meet them.
Financial Reporting - The strategic challenge
By Mukul Pareek

Background

As business is carried out across the world, large amounts of information is constantly being generated. Much of this information is of great value not only for making clear the internal dynamics of the business, but also for providing a strategic competitive advantage over a period of time.

Information is available to firms from a number of sources, and perhaps one of the most important source is the information that is generated by the firm while it carries out its own operations. This information, while seemingly easiest to tap, is often the least utilized corporate resource. And here we talk of not just financial information, but also the great mass of statistical information that every business produces. This is information about its customers, information about its suppliers, their inventory and also how it impacts the firms own stocks that are carried. Information, and the knowledge that results therefrom, is empowerment. Imagine the competitiveness of a bank that knows its outstanding positions before the end of the day exactly and accurately. Or that of a transporter who knows exactly where his trucks are, what parcels they carry and the condition they are in. While traditional information systems will ultimately provide the information, sheer survival is soon going to be dependent upon accurate real time information. The problem is that while the information is available, it is often difficult to collect in terms of the resources required to do so, and then even when it does become available, it is usually too late to be of much use.

The challenge is not made any easier by the fact that being qualitative or subjective, the bulk of this information is not amenable to be captured by systems and lies in people’s heads, collectively called business wisdom and covered by the larger subject of knowledge management. Only a much smaller subset is capable of being expressed numerically or with precision of any order which is capable of being captured on systems. Even of this limited subset, an even smaller subset of data generated in the course of business is actually captured and recorded somewhere in the large proliferation of systems so typical of most large organizations.

The strategic challenge is therefore to ensure that the most relevant information is captured in the most efficient and consistent manner and is available to the right people at the right time that allows a maximization of the value of the business.


Financial reporting

This article deals with the business implications from Financial Systems that are a part of the information capture and delivery process. Financial Systems include:

Transaction capturing systems – such as SAP, Baan etc fall in this category

Review and analysis systems – These include spreadsheets, and OLAP tools such as Hyperion etc

Reporting mechanism – These are means of delivering the financial information generated to either internal or external consumers.

Financial Systems drive internal and external financial information reporting by providing the transactional systems that capture financial details at various stages of the business process. A key raison d’etre for Financial Systems is to drive reporting, both internal management information on operations, and information required to be revealed to external parties for regulatory reporting or analysis. While Financial Systems form the bedrock for both these types of reporting, their connection with the information ultimately delivered is often through many complex layers of other software products and a series of manual reviews.

There are two key drivers for the financial accounting and reporting business processes:

Information requirements, which can be externally or internally driven,

Business process requirements, eg a client needs to be serviced, a supplier needs to be paid

Basic Business Needs

Generally, any set of financial processes seek to satisfy the following basic business needs. What we see as we move further away from basic transaction capture is a progressive increase in the intellectual input required to meet a particular requirement, for example, while capturing receipt information is a largely manual and considerabley unskilled task, building a forecast on the basis of the the past performance and our knowledge of the future is a far more complex job. Simpler, rule based based tasks lend themselves to being automated using technology, or outsourced to a lower cost location.

Business requirement
1. Basic transaction capture: e.g. General Accounting, Payables
2. Multi-currency reporting needs: e.g. Group reporting currency conversions
3. Ad hoc querying: e.g. Ad hoc reports
4. Aggregation of results: e.g. Area or geographical consolidations
5. Financial consolidations: e.g. Eliminating entries conforming with GAAP
6. Management allocations and transfer pricing Intercompany fees
7. Local fiscal & compliance driven reporting: e.g. Various tax and other submissions
8. Business Analysis: e.g. benchmarking, comparisons, trend analysis, product profitability, activity based costing
9. Financial Planning: e.g. forecasting, budgeting and variance analysis, rolling forecasts, annual budgets





Deliverables from the financial accounting and reporting systems

It is important here to distinguish between the manifest deliverables of the financial systems, and the real deliverables. While the visible deliverables from the financial systems include budgets, forecasts, management packs etc, the real deliverable is improved financial management. Improved financial management takes the form of more informed investment decisions, compensation decisions, and at a higher corporate level even decisions on capital structure. At a strategic level, financial systems drive the metrics that are used to driving the maximisation of shareholder value.

It is with this perspective that we must evaluate any options when we look at the shape of these systems in the future.



Basic business needs revisited in some detail

1. Transaction capture

This relates to maintenance of the books, and the need to be accurately able to record all financial transactions as they happen. Transaction capture still remains a largely manual task, though efficiencies can be enhanced by ensuring that the same data is not keyed in again. The term transaction is used in a generic sense to mean an event or occurrence that triggers an entry somewhere in the financial systems – whether the general ledger, receivables or other system.

The following three types of transactions can be identified:

1. Transactions resulting from interactions with third parties, e.g. invoices, bills etc

2. Transactions resulting from accounting or business judgement – these include entries for accruals, accounting estimates, some elimination entries etc

3. Rule based transactions: These transactions can be system generated and are based upon defined mathematical or other rules capable of precise definition – this category includes revaluation entries, translations, exchange differences, rule based allocations, formula journals and the like.

The bulk of the transactions that occur with third parties still need to be transferred from paper to electronic transactional form and in the short term there is no easy way of eliminating this manual work. With the development of B2B transaction interfaces, EDI and mark up languages like XML, the future may see some of these transactions flowing directly into the system with little human intervention– But these are unlikely to have any significant impact in the short term.


2. Multi currency reporting requirements

Multi currency reporting requirements can vary, and include:

Converting one currency to another

Performing computations and analysis on local currencies

Converting transactions/balances to the group reporting currency

Dealing with hyperinflationary business environments (increasingly becoming a rarity)

Multistep conversions like the Euro – an soon the change of accounting currency effective the 1st of Jan 2002.

Applying different conversion rates to the same transactional subset, e.g. budget rates, actual rates and spot/central bank rates.

Most of the above are dealt with by the basic inbuilt functionality of the accounting system



3. Ad hoc queries

Ad hoc queries on balances and transactions often need to be performed by bookkeepers and management accountants alike to answer day to day queries from managers, suppliers or as part of their analysis role. The one chief characteristic of ad hoc queries is the inability to predict what they could be (i.e. they cannot be hard coded into standard reports – incidentally which themselves are often used to answer ad hoc queries).

A related characteristic of such queries is that the results of one query dictate what the next would be, another reason why a suitably flexible ad hoc query tool is required.

4. Aggregation of results

This refers to the pure mathematical summation of financial results. In a completely integrated system, there would perhaps be no need to mention this as a business requirement, but so long as disparate systems with different coding mechanisms co-exist, aggregation would be required. While simple in concept, aggregation is often a precursor to more advanced analysis and consolidations and the chief requirement is transporting results onto one system where they can be added up.

5. Financial consolidations

This refers to the accounting consolidations with inter company eliminations and minority interest calculations. Some consolidation tasks can be automated if the tool used has some built in ‘accounting intelligence’, i.e. can identify inter company accounts and automatically offset them. Some other entries however require accounting judgement. By its very nature, all accounting consolidations must offer an appropriate audit trail and are nearly always subject to scrutiny and reasonableness tests.

The boundary between consolidations and aggregations may sometimes be blurred, for example when different views of the organisation and accounts across operating units are required for different purposes, and elements of both operations can be found. In these cases, if the business requirement is clearly understood, then the categorisation between aggregation or consolidation is an irrelevant matter of mere semantics.

6. Management allocations and transfer pricing

This refers to decision making as to off-ledger adjustments that drive a management focused view of profitability – such as allocated costs and revenues, and includes transfer pricing calculations that lead to transactions in the ledgers. The business need is the timely calculation of appropriate allocations. Sufficient data in a form that allows these numbers to be arrived at should be available.

7. Local fiscal and compliance driven reporting

A key requirement is to be able to produce local GAAP accounts in each of the economic environments where the business operates, and to be able to produce the reports and returns that may be required by law to substantiate these. Prime examples are the Italian Libro Giornali with its prescribed format and numbering requirements, 1099 reporting in the US.

8. Business analysis

This includes the need to be able to perform what-if analysis, modelling, profitability, activity based costing and other decision support analysis. Any financial systems must not only make this easier, it must positively facilitate development and application of such models.

9. Financial planning

This refers to the need to develop and finalise budgets and forecasts in an organised and interconnected manner. It should facilitate population of a budget based upon existing data in a variety of ways, including flexing using currency rates and extrapolation using past results and known trends. The budgets and forecasts should be capable of effortless comparison with the actuals captured by the transactional systems. The budgets and forecasts should be capable of being prepared and used according to a non chart-of-accounts approach.

10. Shaping business and corporate strategy


Ultimately, financial systems help drive the company's business unit strategy and corporate strategy by providing the information that managers need. Of course, strategy building draws upon a variety of customer, competitive and other information, and financial information is only one of them.




Businesses use a variety of tools as they strive to streamline the processes surrounding financial reporting. In addition to various application integration tools that are available, data warehousing solutions in one form of another is often the option of choice.

Data warehousing as a reporting facilitator

A single source of data that is used for all reporting can help overcome data redundancy and quality issues, besides streamlining the flow of data and the different ‘views’ of the same data visible to various parties. A simplistic thematic representation of the data flows involved in such a model is produced below:




Finance and accounting - the IT framework
Pressures on margins are forcing companies globally to reexamine all their cost lines, more so for support functions like finance and IT. This often calls into question the work of the accountants and the value they deliver to the organisation. This paper examines the conceptual framework for financial reporting processes so that the relevance of its various IT components (ERP systems, ad hoc query tools, OLAP etc) may be understood in proper perspective to design reporting processes that maximise value.

Boundaries between applications

Clearly, with the width of the process with requirements as varying as described above, there is no one tool that can address all these requirements in a seamless manner. A combination of different software tools alone can address all these issues simultaneously. These tools may be used by different groups of people sometimes very narrowly focused on their own requirements, but the awareness that they are all part of the same value chain (i.e. improved financial management and therefore improved corporate governance as well) should not be lost and a cohesive approach needs to be taken.