You Have Unity of Purpose, but What about Unity of Numbers? The Importance of Financial Due Diligence in Non-Profit Mergers
Last week, we talked about the initial considerations of a non-profit merger. Once you’ve reflected on the relevant issues and made the decision that a merger aligns with your goals, donors, board members, and mission, it is time for the next phase of the process – engaging in due diligence.
In the scenario of a non-profit merger, due diligence has three primary functions:
1. Minimizing the risks associated with joining two separate organizations to further a common mission;
2. Providing clear insights into each organization’s interests; and
3. Improving the timeframe of the merger by reviewing the relevant documentation and processes, and identifying any challenges sooner rather than later.
Due diligence is conducted by thoroughly inspecting all aspects of the organization with which you plan to merge your own non-profit. The entire due diligence process consists of numerous categorical reviews, including legal, contractual, employment, operational, financial, tax, real property, physical property, intellectual property, and human resources, among others. However, for our purposes, we will focus only on financial due diligence.
Financial due diligence provides an opportunity to analyze potential savings with regard to the overhead of the combined organizations. With this full and complete knowledge, the approving Board Members will have the ability to examine the overall benefits of the merger.
The Financial Audit Checklist
Before you can merge with another non-profit, you must possess a clear understanding not only of its current financial status, but also of its financial history. You must have the ability to answer questions such as: What resources will be available moving forward? And what obligations will remain?
Financial due diligence will include a review of the following:
Audited Financial Statements for at least three years
Annual Budgets, Projections, and Strategic Plans for at least three years
Debt and any Contingent Liabilities
Grant level financial results
Fixed and Variable Expenses for at least three years
Depreciation/Amortization Schedules and Methods for at least three years
Accounting Methods and Strategies
Any Investment Policies
Employee listing with position and annual salary
Detail list of larger donors
While non-disclosure agreements must be executed prior to any due diligence occurring, many organizations have valid confidentiality concerns as they relate to financial reviews of internal documents. As one possible solution, some organizations choose to move forward in a phased approach. In doing so, they leave the disclosure of the most sensitive data and documents to the end of the process.
While each situation will be different, and financial due diligence may vary slightly, it is essential to build a foundation for success. Not only are you protecting the non-profit itself, but also the individual board members and donors involved. Each non-profit should conduct its own independent due diligence, as well as joint due diligence to maximize information and minimize risks. By taking both a historical approach and a forward-looking approach, you will gain an incredible amount of knowledge. And with more knowledge, comes the empowerment to make the best decision for your non-profit.
Barker Associates has extensive experience working with non-profit organizations as they prepare for, and go through, a merger. If you are considering this strategy, use this link to my calendar to choose the best time for a free 30-minute consultation.
I have noted that, even during these days of the COVID pandemic, there is still a lot of money in the PE and VC world that investors must spend for firms to survive.
PE and VC firms invest in companies with a plan to exit the investment in three to five years. The exit can take the form of another investment round at a higher valuation, an IPO, or the sale of the business altogether. Another dynamic is becoming increasingly apparent: PE-backed companies are having an increasingly difficult time implementing an exit and/or raising the next round of capital.
Why the difficulty, when there is an incredible amount of money for investors to invest?
The primary factor leading to next round challenges is the enhanced due diligence investors are performing now compared to pre-pandemic. The long run of economic gains nourished a confident exuberance in investors where the investor had to believein a company’s financial projects similar to how Dorothy had to believe in Oz … without much evidence. The supply of capital outweighed the supply of companies to the point that investors were willing to lower the bar for the due diligence completed on sales and financial projections, data rooms, and balance sheet liabilities.
The current atmosphere based ona stricter due diligence process represents a correction that goes back to the core fundamentals of investing.When the pandemic dust settles a bit, the correction will result in a more sustainable environment for the PE and VC firms. In the meantime, portfolio companies must place more focus on the following areas to support due diligence efforts:
Data rooms. Companies that cannot produce supporting documentation for their financial and sales assertions are destined to fail due diligence. Deals fall apart when a company cannot produce contracts, proving professed commitmentsordemonstratingcompliancewith the contract terms.Be prepared for due diligence efforts by appointing a trusted, organized document manager to oversee your data room. Read more about data rooms here.
Projections.Think like the investor—play a great game of Sesame Street and make sure that one of these things (your financial projections) looks like the other (your historical trends).Practice the dialogue spoken regarding your company’s future to ensure it rings true to what you can support based on data and research.
Historical financials.Your financial data must be accurate and easyto follow by potential investors.When you produce complicated financials that require confusing explanations or take too long to organize, you put the deal at risk. Just like a burglar will move on from a house with a security system, investors are glad to move on to the next deal that requires less effort to close.
If you are a founder or a C-suite executive of a fast-paced, growing entrepreneurial company, are you prepared for the next round of funding or other exit strategy? Let’s talk about how to begin organizing your data room, simplify your financials, and produce realistic, evidence-based projections that investors will find credible.I would love to speak with you about the challenges you face in preparing your exit strategy. I invite you to set up a 30-minute free consultation with me by clicking on this link to my calendar – let’s talk!
Are you wrapped around your pet’s little paw? We are, despite the fact that we recently learned they will lie to us.
Last night, I fed our Maltese and Bichon Frise their dinners and went about my evening activities. Later, my husband, Glenn, came into the kitchen and the little guys acted as if they had missed their dinner. Given the circumstances, he, of course, fed them again.
While our dogs may lie about whether they’ve eaten yet, some things never lie, such as the real data you need to run your business each day. And whether or not you intend to, it’s the same data you need to pitch to investors when seeking funding.
With the right infrastructure in place, you have answers at your fingertips, such as:
What is the seasonal fluctuation of my business so that I can prepare for the ups and downs?
What is the demographic profile of my customers so that I know where, when, and how to reach them?
What is the average cost, price, and profit of a sale? Am I losing money on my best sellers?
These questions and many more can be answered by having the right infrastructure in place and capturing the data as you conduct daily business.
What does the “right infrastructure” look like? The answer is different for each organization based on its size and complexity. At a minimum, an organization should have a list of existing and potential customers and a system to maintain communications with them. The optimal tool is an integrated Customer Relationship Management (CRM) system. An organization also needs to manage money and financial information to project cash flow for the next 12 weeks, have the correct information for tax compliance, and make the appropriate strategic decisions. This may mean you need a separate billing system and/or General Ledger. You also need to properly set up your General Ledger with the right coding segments to be able to report on profit and loss by product, location, customer, and department, among others.
If you feel that you are blindly making decisions about hiring, marketing, warehouse space, or any other issue, remember the numbers don’t lie. Let’s talk one-on-one in a free consultation to get you in the right direction. Check out these times on my calendar and choose the one that is best for you.
Don’t Just Hope For the Best – What Does the Data Tell You?
For months, the headlines have screamed that millions of small businesses will file bankruptcy due to impacts of the COVID 19 pandemic. Perhaps you have had the thought in the back of your mind, calculating how many weeks you can remain in business before considering closing your business and possibly even filing for bankruptcy.
Don’t just wonder – take steps to gain a confident understanding of your business’s financial position.
Communicating with your banker and investors effectively is essential during these times of economic upheaval and doubt. To do so, you must have the right financial data to inform yourself, and then to inform your financial support team if you will struggle to make payroll in a month or two. What you need is a 12 week cash flow projection.
Instead, you are hunkered down, uncertain of your cash position, keeping silent and hoping for the best.
This is not a great strategy. The most important thing you have as a professional is the trust you gain over time as other professionals recognize you do the right thing. I recently had a Senior Executive of Marketing where I was serving as an Interim CFO say that they appreciated my intention to always do the right thing and recognized how much it helped the team feel more comfortable. Prior to that comment, I would have never dreamed someone in marketing would notice.
Bankruptcy is not the only option if financial projections indicate your business is in serious trouble; in fact, your business has to qualify to file Chapter 11. The Small Business Reorganization Act of 2019 has created other options for small businesses (set to expire in March 2021) to seek protection from debtors. The key to moving to the next step is for you to communicate pro-actively with all parties and let them help you understand your position as well as the options available to you rather than using hope as a strategy.
Empower yourself with knowledge and get the cash flow projection you need! Listen to a podcast where I was recently interviewed about cash flow here.
If you need help starting the conversation with your financial partners and stakeholders, I invite you to set up a 30-minute free consultation with me right now by clicking on this link to my calendar – let’s talk!
Those of us who work to manage our cholesterol have received conflicting information about eating eggs. I grew up loving eggs, but then, as an adult, I was told not to eat them due to high cholesterol.
Then the nutrition experts decided you can eat egg whites. Now it is back to eat your eggs – yolk and all – the last time I spoke with a nutritionist. Confusing.
Deciding if you are going to outsource a function within an organization is about as confusing. The trends go back and forth on that issue too. Advances in technology and lower costs of offshore professionals have made the idea of outsourcing more attractive in some cases.
I have some advice, gained over my years as CFO in various organizations, for you to consider while you evaluate the idea of outsourcing financial functions:
Don’t try to fix a broken process by outsourcing it. Do not outsource a recurring, detail-oriented process that is currently broken. Get the best consultant you can afford working to fix the process. Make certain the expert who fixes the process creates a training manual on how the process should run and trains an internal staff person on it. You may discover during this process it is easier for you to keep that process going with your own employees or you may decide you want to outsource the detail part of it to an outside, less costly resource. The bottom line is that if you do not understand your own process, you cannot know if a third party is accurately performing it on your behalf.
Get organized. Organize your data in a way that you can provide it to the outside party prior to engaging them. If you cannot make sense of your data, you can end up paying a third party a lot of money to do it for you.
One of the areas I’ve seen this as an issue is with State Sales Tax. Compliance in this area is about as difficult as hanging upside down from a tall tree branch while flossing your teeth. Companies get frustrated with the complicated process of filing state sales taxes, especially when multiple states, or states with complicated calculations and forms are involved. For example, are you capturing sales revenue based on the billing address or the shipping address? You must have accurate data before outsourcing it for someone else to handle.
My recommendation is to invest in upgrading your IT infrastructure. Regardless of whether you are outsourcing compliance with state sales tax or another process, you must be in a position to produce data in an organized manner that a third party can accept and act on.
When you do decide to outsource a portion of your business, make sure you keep the data and regularly backup the data the outsourced agency is using. Make sure you still know where your information is and how to get to it if the outsourced entity suddenly goes out of business. Perform routine oversight of the work being done by the third party. This is even more important today in this every changing business world.
Just-in Time Experts. Expertise that you need infrequently is a great area to consider outsourcing. Many third parties provide outsourced IT, legal, human resource, or financial expertise to augment internal resources and are less costly than hiring the expertise full time. You may only require specialized expertise for specific projects rather than an on-going need.
Outsourcing these functions is not without its drawbacks. For example, let’s say your obsolete, no-one-has-ever-heard-of information system gets hacked and you have no in-house expert who is familiar with your system. Hiring an expert to support obscure software can be costly and time intensive to get your problem solved.
Or perhaps legal expertise is something you only require occasionally. You decide to download a customer contract from the internet instead of hiring legal expertise to prepare your standard contract. If you get in a nonpayment dispute with one of your major customers and then bring in legal to help you, you may discover that the customer contract you downloaded for free from the internet will not allow you to properly recover the revenue you are due. Now the outside lawyer has to clean up the mess you made by not hiring them on the front end to prepare a sound contract.
My point is that it is essential the right expertise performs the company’s core functions in every business. The laws and regulation in these areas change rapidly and you need someone to help you stay compliant and out of trouble.
Barker Associates provides outsourced Chief Financial Officer services on a fractional or full-time basis in the event of a transition. Fractional services work best during times of fast paced growth, a new system implementation, a merger, or an acquisition. Even with a full time CFO on board, they have a day job and these types of changes require a unique focus and background. Our extensive and diverse background helps guide the organization through the change.
During a transition time, Barker Associates uses their expertise to assist the organization with designing a job description and interviewing candidates for the new position. Once your new CFO, Accountant or other financial professional is onboard, Barker Associates exits until you bring us back for the next big project.
If you are considering outsourcing a financial process within your organization and would like to discuss specific areas of concern, I would love to speak with you. Click here to schedule a 30-minute free consultation to discuss your unique situation.
the word audit make your pulse race and put your antiperspirant to the test? Is
your monthly financial review fraught with the same level of fear that a trip
through the Halloween Hall of Terror brings? If you are a growing company and
are required to go through your first audit, it can be scary. The fear of the
unknown, worried what may jump out at you as you dig deep to tie out a balance
can create real panic.
than sweating bullets and launching into panic mode, think of an audit as your
annual wellness check-up and not an attempt to incite fright. If you eat right,
exercise and take care of yourself your check-up typically is not cause for
concern; but if you’ve consumed one too many lattes or value meals and ignored
what you should be doing, the scale and your doc will remind you to pull it
together and get back on track for a clean bill of health.
audit is very similar, but instead of your doctor, it’s your CPA telling you to
get your business organized and your financial health on track for a clean
opinion on your audit. An audit is beneficial in many ways, but essentially an
audit provides peace of mind that your financial statements paint an accurate
picture according to Generally Accepted Accounting Principles. This assurance
is vital if you are growing and need funding or if the funding you currently
receive has compliance requirements.
An audit is important, but it doesn’t have to be as scary as looking into a funhouse mirror. Follow this 5-step process, before your audit begins, it’s like having the answers to the test and will provide you with the clarity needed to minimize anxiety and help you master the mystery behind the first-year audit.
with your CPA.
CPA is hired to help you and is not out to get you. Have them set the stage for
what you should expect during the audit. Ask them what documents you will need
to provide and what tasks you should complete before the audit begins. Talk
about the timeline, when will it start, how long will it take? Who will be the
primary contact to ask questions and submit documentation? A little fact
gathering on the front end will go a long way to help the audit process move
out a project plan
the information provided during your initial meeting with the audit firm and
identify the tasks that need to you will need to complete. Assign the
appropriate person to the task and determine a deliverable date. Work with your
team to ensure that tasks are appropriately assigned and document any
dependencies and concerns that may interfere with the deliverable date.
Communicate with your team and launch the project
kick-off is essential. A proper kick-off demonstrates leadership supports and
identifies the objectives to accomplish as well as risks, assumptions,
dependencies, and timeline. Many of the teammates that are responsible for
supporting the audit are completely busy doing their “day job” and
don’t have a ton of extra time. Communication upfront with clear requirements,
expectations, and deadlines will help them to plan appropriately to coordinate
the additional work into their schedule so they can work much more effectively.
Clarity is the antidote to anxiety. Effective leaders are clear.
the most frustrating aspects of an audit is related to cost increases. Additional
costs arise because the audit team has to do extra work to clean up your mess. Many
times, clients can avoid costly increases to their audit bill by ensuring they
have all their documents in order. For instance, are your accounts reconciled?
Do you have supporting documentation for revenue and payments? What about lease
schedules, do the payments tie out and do you have addendums and invoices to
support lease and CAM payments? Does your trial balance tie out, and is your
general ledger mapped appropriately to your financial statements, including the
statement of cash flow? Get organized, make sure your accounts tick and tie and
have the appropriate documentation on hand.
Review your progress
regular touchpoints to communicate progress. Think agile. In the IT world
during implementation, the team meets for 15 mins each day to give a quick
overview of the task they need to complete, progress, and concerns. Short,
frequent meetings allow the team to stay in synch, mitigate risks, and provide
support along the way. If you know how everyone is progressing, there are fewer
surprises, and likely you can head off any significant delays or concerns.
the time to follow the steps. As a former auditor, I’ve come to learn that
prepared clients are collaborative, not combative. Their team is happier, well
informed, productive, and the result is peace of mind and financial clarity. A
little communication, structure, and organization go a long way to help you and
your team manage the process and stay on task, bringing you one step closer to
a clean bill of health for your business.
Do you need help solving audit mysteries or getting organized? Barker and Associates can help you overcome audit anxiety and set you and your business up for success. We’ve created a Year-End Checklist for Audit Preparation that will help you streamline the process. Click the button below to enter your email and we will send the checklist to you right away via email.
Recent posts discussed new regulations and the unintended consequences that companies are, or will experience as a result. ASC 606, already in effect for public organizations, affects nonpublic companies for annual reporting periods beginning after December 2018. The South Dakota vs Wayfair ruling last year has impactful implications for businesses who qualify to pay sales tax. Together these regulations are like tsunamis that are overtaking public and private organizations.
These tsunamis can significantly impact your business large or small. Organizations tend to frequently hold off on systems upgrades and acquisition integration noting they cannot afford it. The combination of these regulatory tsunamis transitions the conversation and makes it imperative systems work seamlessly together. The organization cannot afford for that not to happen.
These tsunamis share common implications to you – in order to complete the analysis of how each will impact your organization and to implement the proper accounting, you must have good clean customer data in a system with strong month-end controls; and you must have the actual executed customer contracts – all of them. In my experience with organizations of all sizes, these requirements are problematic because they just don’t happen. What I find is that customer data is scattered throughout multiple databases and spreadsheets, month end processes end up being shoot-from-the-hip events and customer contracts are in various states of execution due to lack of strong contract administration.
These issues are even worse for organizations that have decided we are going to work “smarter,” – a buzz word I hear associated with the elimination of the administrative assistant position. The Ivory Tower people who have just deposited a one million dollar sign-on bonus in their bank account for a C-level position at a public company are going to have a press release and investor call where they talk about how we are going to work smarter, etc.; then the staffing cuts happen. I see the administrative positions go fast.
The administrative assistant is often the traffic controller of the organization. Read my post, Who is your Betty about this critical role. Critical because, once that position is eliminated, contracts and corporate documents are all over the building, saved on laptops that may or may not be backed up somewhere and are reimaged when the person leaves. In the past year, every single time I have been involved with collecting customer contracts for due diligence or some type of project, the C-level person I am working with has had to call the professional on the other side of at least one contract and ask if they have a fully executed copy. This is a HUGE and embarrassing issue occurring in companies, regardless of industry and profit-status.
Accurate contracts and clean customer data are required for any hope of achieving compliance with ASC 606 Revenue Recognition and the interstate sales tax impacts from South Dakota vs Wayfair.
Sales Tax – the Wayfair case is highly technical when you dig into the guts of it, and I wrote about some of those technicalities previously. Here are a few points to keep in mind as the impacts of this ruling become more concrete:
The threshold for reporting Sales Tax is $100,000 OR 100 transactions. What about your college student making and selling hairbows cheerleaders around the country on Etsy to? They better not send 100 hairbows collectively to certain states unless they are prepared to collect and submit sales tax.
State and governmental entities that are in charge of regulating this probably do not have a plan on how they are going to accomplish this. Are they going to stop every long haul truck coming into the state? Look in every mailbox? I am not sure how they are going to find you!
Since the law is retroactive you may have a big liability out there that you do not know about. Why – because you cannot locate the contracts or analyze data because you have none that is clean. Instead, you may have to guess what states, how many transactions, how much it adds up to.
If your organization undergoes an audit or wants to pursue a capital raise or total sale – this can be a huge problem.
Respect your accountants and know they have a difficult job to maintain all of these controls. CPAs, in general, are not the best at standing up for themselves and making sure they have the right infrastructure. CEOs and Boards tend to hire in the Marketing and Sales areas and cut in the Accounting side. IT systems are not upgraded and maintained properly, which further complicates the job of maintaining clean data. Speak up – challenge the impact of short-sighted decisions.
Barker Associates helps small-to-large businesses, especially entrepreneurs, improve performance and increase financial stability. Contact Barker Associates at email@example.com.
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.
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· Free ePayment vendor selection checklist
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.
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