Heading Off Unintended Consequences
In recent emails, I’ve updated you on regulations going into effect this year as well as consequences we realize from previous legislation (namely, SOX). The legislation was enacted because of the erosion of accountability in this country. How do you hold your company accountable while also raising the bar for maturity of processes? Here are my recommendations, based on my experiences in private equity firms, for-profits and nonprofit organizations. It means going back to the basics that technology may have allowed inexperienced staff to circumvent.
Assess Your Procedures for Payments and Bank Reconciliations
Paper checks – Get rid of them; but if you must have them, make sure to use Positive Pay through the bank. Positive Pay uses information from a file that you provide to the bank each time you process checks. As checks are cashed or deposited, your bank compares the checks they receive against the checks you wrote to ensure they match and are not duplicated.
ePayments. If you can eliminate paper checks, consider using an ePayment service. Such services provide a comprehensive payment process with built-in controls. The due diligence process to determine which service will work for you can be overwhelming, but you can request a free ePayment vendor selection checklist I put together with the information you will need about your company and the questions to ask potential vendors during the evaluation phase.
I applaud companies who had the foresight to move to the ePayment process. Make certain the IT department has proper documentation on how the process works. With low unemployment and the resulting turnover, you do not want to find yourself with no one who knows how to push the buttons and fix this if something goes wrong with the process.
The checkbook is a thing of the past, and many young accounting professionals would not know what one looks like. I have asked many accountants, as they are processing a stack of checks, how do you know you have enough money in the bank account to cover those checks? Most of the time they put a very proud smile on their face and report, “I checked the online bank account balance this morning and there is plenty of money to cover the checks.”
After I hear this, I work to control my facial expression. I should become a poker player so I can practice the poker face I need when I hear this response.
So, I ask, “What about the outstanding checks that have not cleared the bank account? What about the auto draw of ongoing expenses like rent and other items? How do you account for that? Do you maintain a checkbook?”
The responses or reactions run the gamut from blank stares, to statements such as, “I keep a running total in my head,” “The checks we issue get cashed quickly.” These answers only serve to challenge my poker face so that I can keep good customer relations. Rarely does the person I am asking show me the checkbook kept in the general ledger system and a proper cash reconciliation they prepared for the previous month. I find this lack of process in organizations of all sizes.
Bank reconciliations. In general, if the organization has escaped the Sarbanes Oxley controls, which, as I stated before, more and more are doing to escape the enormous and overreaching regulation, there is no timely bank reconciliation.
Make sure that, at a minimum, these controls are in place:
- Blank checks are locked in a secure place and only check processors and checks signers have access to them.
- Ensure there is a review of the bank reconciliation and the bank statement two times a year by a C-Level executive, Finance Committee or Board member or investor. Request a free step-by-step bank reconciliation checklist on how to do this here.
This is a true story. I received a check for payment from a large, publicly-traded company. I was shocked when I received the same check number for the same amount twice in the mail. I called the insurance company to report it, but they never called me back. I received a letter about the duplicate check weeks after I had received the second check and made the phone call. The letter I received was very factual and did not offer an apology or do anything to try to mitigate the branding impact. This was a shocking revelation to me that the lack of controls over payments was everywhere.
Get Corporate Credit Card Usage Under Control
Credit Cards – If the US government ever creates a Corporate Credit Card office, I am going to run for the position and work myself out of a job. Corporate credit cards are a nightmare to manage in all companies, from small to large.
Large, publicly traded companies hide behind the fact that they are audited to ignore credit card controls. Yes, you are audited, but the corporate credit card balance is small and immaterial, which means it does not meet the audit criteria for detail testing. Remember, the outside auditors are focused on what the SEC is going to ask them about – the corporate credit card is not on the list. Many small, fraudulent credit card transactions can add up and instill a culture of weak financial responsibility in an organization.
In small organizations, the office manager, bookkeeper, (remember the one who figured out how to print a check out of QuickBooks?), or even the receptionist has a company credit card. This usually happens when a C-level person realizes they may have to pick up the toilet paper at Sam’s Club with their credit card and they do not want to. It’s OK to delegate that responsibility as long as controls are in place to prevent fraud and misuse.
In my work with all sizes of organizations, I have found that often they do not have a credit card policy. Get a policy, even if it is short and sweet, and have each employee sign it who is holding a company card. Email me for a free credit card policy template to get you started.
Fraud on corporate credit cards is running rampant. Often the employee is incurring small, unauthorized charges that add up to a significant number. The Accountant, Purchasing Manager or whoever oversees the corporate credit card may be faced with ethical dilemmas every day when executives in higher positions are the guilty parties. Such situations make it difficult to manage and monitor effectively without a signed policy as backup.
Small organizations and nonprofits tend to have no automation of the credit card process, relying instead on cardholders to provide receipts for accounting purposes. When cardholders are late in providing the receipts, accountants set up a holding account in the General Ledger, (which is often QuickBooks), where they charge the payment of the credit card to avoid paying late. With no accountability for the balance sheet reconciliation, the account just grows. If the accountant responsible for collecting the receipts takes their job seriously, they will walk around the building asking for the receipts and, as an added bonus, hit the goal of 10,000 steps on their Fitbit – the search for the receipts will take care of that!
Tighten up controls on the use of corporate credit cards with these process improvements:
- If you work for a public company and have authority over credit cards, set up a process where the Audit Committee of the Board has someone designated to review a monthly or quarterly report of corporate credit card usage. Internal Audit should be reviewing executive expense reports and corporate credit card statements annually. I suggest they pick randomly from the group for about 10% coverage each year and always review the CEO and CFO.
- Nonprofit Board – make sure there is a policy that each cardholder signs. Review how the process works and suggest implementing automation of credit card receipts. Expensify, or a similar technology tool, can serve that purpose.
- Private company – Set up automation of collecting credit card receipts and a review process like the one described for nonprofits.
Readers of this email who work for well-organized companies with mature practices in place may be thinking, “Surely there are not companies operating without these fundamental business practices in place.” My response is that if that was the case, I would not be writing on this topic or asked repeatedly to present these concepts to audiences!
You can easily implement the actions from this post. I’ve made the tools available for you for free.
Get them sent straight to your inbox and download the ones you want.
· Free ePayment vendor selection checklist
· Free step-by-step bank reconciliation checklist
· Free credit card policy template
Simple click here – Yes, send me the free tools.
If one of your 2019 goals is to build up your company infrastructure with financial process improvements, Barker Associates can help. Contact us today at email@example.com
Find the other related articles here:
Unintended Consequences of Regulation,
ASC 606 Revenue Recognition
The Sarbanes-Oxley Act has created several unintended consequences including, in my opinion, eliminating many basic company controls it was intended to enhance in the first place.
Sarbanes-Oxley (SOX) became law in 2002 and was shortly followed by more regulation and the creation of the Public Accounting Oversight Board (PCAOB). SOX has created many interesting dynamics and consequences, which I will elaborate on in this post. Initially, public companies struggled with how to define a “control” to document that could be used to monitor compliance with Sarbanes-Oxley. I related it to one of my past roles where I was required to read two magazine articles a quarter to maintain my technical knowledge. The way the control was written, it seemed I could read any magazine article to maintain compliance and I was uncertain how an article in People or Cosmopolitan was going to help fulfill this control. SOX regulators and my supervisor both needed to tighten up the definition of “control.”
Since 2002 there has been significant, well-documented analysis of the requirements related to SOX, leading to very specific rules and oversight. The result in the public sector is that the audit team who is auditing for compliance now must to try to keep the regulators from sending them letters and questions about controls that may not be the most strategic as it relates to the health of the company. The auditors then, in turn, have their hands full during the audit process reviewing these types of controls, making it harder for them to add value and help with overall strategy. They have less time to step back and analyze the numbers in a way that results in a critical eye on the company’s financials, as they are auditing to the specific regulation to prevent the SEC from having a reason to come after them.
The increased regulation has flowed into the AICPA audit guidance, enhancing the rules of all audits; consequently, the cost of audits has increased for public and private sector companies. One of the most impactful changes has been the enhancement of the rules around auditor independence, including:
- The auditor can no longer prepare the accounting records of the company they are auditing at all. Twenty years ago, if an auditor identified a small issue or difference, that auditor could determine what adjustment was required and make the entry to the financial statements. Now the auditor must communicate the finding to the client and request they analyze to determine what the entry should be and submit the entry to the auditor. Especially in smaller companies, the staff may not have the specific expertise to carry this through. These types of delays in the audit process drives the cost up.
- The public company can not hire partners and managers on the audit team while they are working on the audit. Twenty years ago, public companies would frequently hire professionals from their audit firm who were already familiar with their company and the culture. The SEC was concerned this impacted independence because if the auditor is expecting to be hired and receive a large salary, they may not work with complete independence.
- The peer review regulation has been enhanced, requiring even the smallest audit firms participate in peer reviews. However, a small CPA firm has a difficult time allocating the time to either host a peer review of their work or go to another firm to perform a peer review on their work.
Those were some of the enhancements. Now for the unintended consequences of regulation:
- Partners in big CPA firms are leaving the practice as they are tired of dealing with the PCAOB inquires while still having to complete their audit responsibilities.
- The number of companies entering the public market with IPOs has declined over time as they are unwilling to incur the cost to comply with public reporting. This trend reversed in 2018; there has been an increase in IPOs as noted in the EY Global IPO trends Q4. Most of the increase is in the healthcare and technology sectors as you can see in this report from EY.
- The typical entrepreneurial growth company does not have the disruptive technology and the ability to attract multi-billion-dollar valuations. Take Farfetch (FTCH), for example, who commanded the initial $6.2 billion valuation after the first day of trade in September 2018, with a $112 million loss in 2017. Farfetch’s valuation will make it worth the increased regulation of a public company. This example is the exception rather than the norm.
- The cost of an audit for both public and private companies has increased significantly. As a result, many companies subject themselves to an audit when it is necessary. Recently, I learned of a company that was required to get an audit to comply with the buy-side due diligence of their potential acquirer. The cost of the audit was double the original estimate, significantly delaying the sale closing.
- Private Equity firms struggle getting through buy-side due diligence without having audit reports or typical systems infrastructure and controls upon which they have historically relied. The standard of requesting an audit has been lowered and the Quality of Earnings (“QOE”) report is being used more often.
- Public company accounting and finance executives are expending valuable energy managing to the specific concerns of the PCAOB, leaving inadequate time and mental space to think strategically and apply judgment to controls in their environment.
- The companies electing not to have an audit due to the cost may not have proper data and information to run the business day-to-day, which an audit would reveal.
- By choosing not to pay for an audit and the value a third party brings by reviewing their controls, the company may not have adequate controls, leaving companies more vulnerable for fraud and embezzlement.
- High growth companies have grown without the benefit of audits and may be using a combination of QuickBooks and an Excel spreadsheet explosion to maintain their records. The accounting team may not be reconciling balance sheet accounts and applying proper month end closing process. When the company seeks outside investment or desires to implement an exit strategy, they may find themselves in a situation where they must get an audit completed. The cost of an audit will likely be enormous at that point, as the books are probably not ready for an audit and chances are the existing staff may have never gone through a process of preparing a company for an audit.
SOX and PCAOB are certainly necessary in the United States regulatory environment. Public reporting and transparency are necessary for investors to be properly informed. The regulation should be reviewed and “right-sized” for the current environment. It is a shame that a few companies with less-than-stellar ethics, like Enron, led to a set of rules that has grown into such a powerful force. The PCAOB is not strategically focused on keeping businesses in business, and C-level executives should be pushing back for regulations that help businesses and against those controls that waste time.
Private companies that feel they are unable to afford an audit should keep their books and records so they are auditable. Basics such as monthly bank and balance sheet reconciliations and proper month end cut off should be a normal business practice.
Other articles of interest:
Instant – Not Always Good
The New Sales Tax Laws- What You NEED to know!
When you scale you need to have a more analytical approach of targeting and segmentation, but in the beginning, it’s more much qualitative. (Pavel Malos 6/11/18, uxdesign.cc)
Chief Executive Officers, Board Members, and Investors have a fiscal responsibility to ensure an organization can handle planned growth. For-profit business leaders must back up the strategy with the right level of working capital and financial infrastructure. Nonprofit leaders must make certain they have the right financial and fundraising data to analyze and plan effectively.
QuickBooks and other simple financial programs have elevated the confidence of professionals, not trained in accounting, past their competence. These systems allow you to process the basic information easily; however, the non-accountant may not have applied the required strategic thought process to the design of the infrastructure that a trained and experienced financial strategist would apply. Some entities can be run effectively in QuickBooks, and the financial data can be analyzed if the infrastructure is set up properly in the beginning.
All organizations need to have financial information, in proper segments in the General Ledger and make sure there are proper period end procedures. Lack of proper information can lead to performing services or selling product at a loss, non-compliant reporting and a lack of proper cash flow. All of these issues can lead to an untimely end to any organization, for-profit or nonprofit. We have all heard of employees showing up for work one day to find the doors locked and an abrupt end to their job and paycheck. Sometimes these employees learn their employers have not remitted federal income taxes, deducted from their paychecks, to the IRS and they have to pay the taxes again. Leaders of organizations should listen to their financial leaders when they request upgraded systems and more people to account properly for the organization’s financial data.
Leaders who make it a priority to set up, manage and monitor metrics have thought through configuring their reporting infrastructure. Leaders without such foresight run through their day-to-day life worrying about how to make payroll and pay bills, with little to no awareness about which decisions are working and which are not working to scale growth to new levels.
Barker Associates has the unique ability to work with all sizes of organizations and building infrastructure that matters. Contact us today!
Mindy Barker, Founder & CPA | Jacksonville, FL 32256
(904) 394-2913 or (904) 728-2920 | CFO@MindyBarkerAssociates.com
During an especially stressful day, I decided a Whole Foods Green smoothie was just the thing to help relieve the cortisol I felt building in my system. Their green smoothie is one of my favorite drinks, I can just feel the goodness going down. I ran into Whole Foods, straight to the juice/smoothie counter. There was no one there and I eventually noted a sign that said the juice bar had been moved to the coffee bar – on the other side of the store. I hiked all the way across the store, walked up to the coffee bar and ordered my smoothie. The barista who was working the counter had the unfortunate duty to tell me they no longer had smoothies – a self-serve juice bar – but no more smoothies.
By now my cortisol level was probably off the charts, as I walked away, announcing to shoppers on the juice bar aisle, “Well it looks like Whole Foods has gone to ‘The Man.’ How could Amazon and Jeff Bezos determine that their delicious smoothies had to go away. That was one of my favorite things at Whole Foods!”
Who is “The Man”?
For those who grew up in the post-‘60’s era, “The Man” is slang, often derogatory, that may refer to the government or other authority in a position of power. Resisting The Man’s way of doing things was (probably still is) considered being a nonconformist. When I hear people say, “I am not working for The Man,” my interpretation is that they all want to be entrepreneurs, not stuck behind a desk complying with rules.
Later that day, when I had calmed down a bit, I realized that my annual expenditure of 3-4 Whole Food green smoothies probably did not warrant keeping smoothies in the product offering; the personnel required to man the bar and maintain the low customer demand was probably not cost effective.
Wait a minute! Does that make me the smoothie crusher? Putting on my Financial Strategist hat, I thought about the clients I help analyze revenue and costs to determine if they are making money on product lines; and if not, help them strategically determine what changes can help make the business more profitable and increase the enterprise value.
If you are making decisions about finances based on very short-term needs, like making payroll or paying bills without the right financial information and analysis, you could have unprofitable green smoothies throughout your organization and not be aware of it. Continuing to offer green smoothies at a loss is a strategic decision you should make based on facts. At times it is warranted.
Business professionals in both the corporate and non-profit world often move out of that world to get away from “The Man.” They feel worn out from the suppression an employee feels trying to make a difference in the face of bureaucracy. They have the desire to impact society by providing great products and services for all. Their exuberance can lead to unprofitable (or unsustainable) business products, programs, and lines of business that persist for years if the leader does not respect the need for quality financial information and commit the infrastructure to get it. And to take that one step further, leaders must also invest the time to analyze the information and make strategic decisions.
Respect the Need for Financial Infrastructure
I have gotten over the loss of my green smoothie and will persevere through the change. What about you? Could you be a leader with unprofitable green smoothies, leading your organization to a negative cash flow abyss that will be difficult to dig out of? Respect the need for financial infrastructure and take the time to analyze it.
Barker Associates can facilitate a review of your product lines, current financial infrastructure and processes to determine the next steps for your organization. Be “The Man” in the positive sense, by using timely, reliable financial information to think strategically and move your organization forward.