The Virtual Close Myth or Reality?
According to a 2001 joint research study by Hyperion and Hackett Benchmarking, many companies still struggle with long financial consolidation and reporting cycles, hindering corporate decision-making abilities. In 2001, the average closing cycle for companies was six business days, and the average reporting cycle was another 5.4 days.
Conversely, world-class companies are completing the entire closing and reporting cycle in fewer than five business days. The most acute case is the virtual close, whereby the books are closed in a matter of hours – a nirvana few companies have yet achieved. However, companies that close their books quickly and deliver more timely information to management are well positioned to implement a business performance management solution that provides competitive advantage in a rapidly changing marketplace.
Consider this scenario: It's three weeks after the quarter end. Marketing is clamoring for revenue and profitability results by product. But you are still struggling to close the books and deliver the information needed for the quarterly earnings call. You're wondering if you should have pursued a career in music instead of accounting!
In this uncertain economy, business decision-makers must keep a steady finger on the financial pulse of their companies. Now, more than ever, line managers must scale operations up or down rapidly and reallocate resources quickly to seize new opportunities as they arise.
New pressures are on the horizon from an external reporting perspective as well. In February of 2002, the SEC proposed more than a dozen disclosure rules to give investors a better picture sooner of publicly traded companies. Requirements to accelerate the filing of 10-Q financial statements from the current 45 days to 30 days from a quarter's end, and 10-K annual reports from the current 90 days to within 60 days of fiscal year end, are among some of the new SEC rules. Investors are also demanding more transparency into the corporate books and higher levels of accountability by senior management regarding the integrity of financial results.
Most companies are challenged in delivering financial information on a timely basis. Period-end financial closing and reporting processes take weeks to complete and fail to deliver the right details required by decision-makers and external bodies.
According to a recent research note by John Van Decker, program director for the META Group, "By 2005 or 2006, leading organizations will have gained competitive advantage, with days trimmed off their closing process, by simplifying accounting processes, focusing on delivering key business metrics to management, and deploying IT solutions to produce results in a more timely manner."
With top-line and bottom-line improvements around the corner, what steps can a company take to shorten the financial closing cycle and deliver the right information to the right people at the right time?
Challenges in Financial Consolidation and Reporting
To the outsider, financial consolidation and reporting might appear to be a simple process of collecting data, adding up numbers, and formatting the results. However, the process is far from simple especially in today's rapidly changing and increasingly complex global economy. Let's look at the typical process for a multinational company with operations in North America, Europe, and Asia.
The first step in the financial consolidation process is to collect data. Few companies have adopted a standard ERP system across their organization and most large companies have a number of different ERP or general ledger (GL) accounting systems across various divisions and locations of the company. Typically, these systems don't organize financial results consistently meaning they each have a different chart of accounts (COA), that is, the line items in which financial transactions are captured and will not be consistent.
Regardless of the system used to consolidate financial results, it must be able to collect data from multiple sources and transform the data into a common view or COAs for corporate reporting. In addition to multiple GL systems, information required for financial consolidation, such as budget data, headcount information, orders, shipments, and inventories, may reside in other systems, such as spreadsheets, human resource systems, or other transactional applications. To consolidate this data, it must be exported from these systems or keyed manually into the financial consolidation system.
Once the data from all divisions, subsidiaries, and locations is collected and "normalized" into a common set of definitions or COAs, the financial consolidation process can begin. However, consolidation requires more than just adding up the numbers. A number of accounting rules defined by the Financial Accounting Standards Board (FASB), International Accounting Standards Board (IASB), and other local bodies must be followed when consolidating financial results. These rules cover aspects like:
- Currency translation
- Elimination of intercompany transactions
- Accruals and other closing adjustments
- Minority ownership calculations
The financial consolidation process is typically an iterative process in which results are consolidated, reviewed, and adjusted a number of times before they are finalized. Once the results are final the reporting process can begin. Reporting is complicated by the need to deliver different information to multiple internal and external audiences in various formats, including:
- Summary balance sheets, income statements, and cash flows for external audiences (SEC, IRS, FDIC, creditors, and local authorities)
- Results by business segment for external use (FAS 131)
- Divisional profit and loss statements for internal use
- Actual versus budget variance reports for internal use
- Trend reports and rolling forecasts for internal use
Numerous other reports are often required to support the analytic needs of internal decision-makers, such as modeling the impact of a potential acquisition or divestiture, the launch of a new product or an increase in advertising spending.
Suffice it to say, the financial consolidation and reporting process is more than just rolling up numbers. It is complicated by the variety of systems, geographies, regulatory bodies, and people involved in the process.
State of the Market: How Companies Perform Financial Reporting
How do most companies handle the complexities of the financial consolidation and reporting process? During a recent Webcast on this topic, Hyperion conducted an informal poll of finance and IT managers and found that more than half of the companies polled are still using spreadsheets and multiple GL systems for consolidation and reporting, and almost half reported financial closing and reporting cycles of 12 business days or longer. In addition, roughly 38 percent of respondents reported that line management is dissatisfied with the timeliness and quality of financial results they receive on a regular basis.
The feedback from this informal poll is substantiated by the results of a 2001 joint market research study by Hyperion and Hackett Benchmarking. According to this study, the average company's financial closing cycle was six days with another 5.4 days for reporting. The top-performing companies in the study reported financial closing and reporting cycles of five business days or fewer. The research study also indicates that many companies are not taking full advantage of technology to improve financial processes.
Speeding the Process: The Virtual Close
At the extreme end of the performance curve are companies like Cisco Systems and Motorola that have adopted the so-called "virtual close." By definition, the virtual close is the ability for a company to close its books at any time, within a few hours notice, and for management to have real-time insight into the state of the business. While very few companies have achieved this ideal, those that have, have undergone major changes in their financial processes, management culture, and financial systems to get there. Necessary management and cultural changes include:
- Reduction in the number of legal entities to consolidate
- Clearly defined key performance indicators
- Focus on top-level results rather than unnecessary details
- Eliminating interim closes
Necessary changes in financial systems include:
- Adopting a single, fully integrated financial application system
- Developing a completely automated consolidation system
- Using an automated single entry, intercompany accounting system, which allows transactions to occur between two different legal entities owned by the same company
- Leveraging a Web portal for delivery of standard reports
- Linking the Web portal to an online analytical processing (OLAP) database thus allowing companies to conduct ad hoc queries and analyses
Companies that have adopted the virtual close did not do so overnight. It is a major undertaking, involving both business process and systems reengineering that may take years. However, there are a number of business benefits associated with the virtual close, including:
- Better decision-making due to timely access to information, decoupled from the financial reporting cycle.
- Managers working from the same set of facts as a result of consistently defined and measured results.
- Reduced costs from the elimination of manual input and reconciliation.
- Increased top-line potential derived from reducing the time spent closing by 40 to 60 percent, allowing more time for analysis of market opportunities.
Financial Consolidation and Reporting Best Practices
Many companies may not have the technical infrastructure to connect all users to a centralized ERP system. However, there are a number of best practices associated with the virtual close that companies can adopt to start improving the period-end closing and reporting cycle. Some examples are:
- Regularly close feeder systems (accounts payable, accounts receivable, and payroll) into GLs rather than waiting until period-end. o Adopt a common COAs across diverse GL systems for consistent reporting across the organization.
- Implement a powerful financial consolidation solution with seamless integration to GLs to speed the data collection process.
- Perform continuous intercompany reconciliation and posting of transactions rather than waiting until quarter-end to reconcile balances.
- Make top-line adjustments in financial consolidation system versus going back and correcting local GLs to speed the consolidation cycle.
- Perform soft closing on the month and hard closing at quarter-end to get periodic views of how quarterly results are looking.
- Conduct flash reporting on KPIs (sales, gross margins, and major expense lines) throughout the reporting period via the financial consolidation system or a performance scorecarding system.
- Report internal results via the Web – self-service finance.
- Enable electronic submissions to external stakeholders (e.g., XBRL).
- Integrate financial reporting with planning, scorecarding, and business modeling systems for continuous performance management.
Companies running multiple GL/ERP systems can easily adopt many of these best practices as a way to shorten financial cycles. In addition, techniques such as flash reporting of KPIs throughout the reporting period can provide management with greater insight into the state of the business without having to perform a full consolidation of the results.
System Requirements for Reducing Reporting Cycle Time
Technology also plays a vital role in supporting these processes and improving cycle time. In the section below, five stages of financial systems are described. Think about where your company stands with financial reporting systems and what the next step might be on the road toward the virtual close.
- Nirvana – Companies with a single, stable ERP/GL system with powerful financial consolidation and other analytic applications.
- Utopia – Multiple instances of same vendor's ERP/GL system with a common COA and powerful financial consolidation and other analytic applications.
- Right Direction – Multiple vendor ERP/GLs with common COA, financial consolidation, and other analytic applications.
- Mainstream – Multiple ERPs with different COAs and basic financial consolidation capabilities.
- Room for Improvement – Multiple ERPs with different COAs and spreadsheet-based financial consolidation system.
Realistically, achieving a single stable ERP/GL system may still be out of reach for many companies. Even then, mergers and acquisitions can introduce new data sources. However, companies can still benefit from the advantages offered by the single ERP/GL system by standardizing on a single vendor's GL, implementing a common chart of accounts across the enterprise, and using a powerful financial consolidation system to quickly collect, consolidate, and deliver results via the Web.
Based on Hyperion's research, the majority of companies appear to have multiple ERP/GLs with different COA's and also provide some basic financial consolidation capabilities through leveraging spreadsheets, a modified GL system, or other custom applications. While this approach may work well for smaller organizations with fewer subsidiaries and locations, spreadsheet-based and custom solutions become unwieldy as the enterprise grows and the financial consolidation and reporting process becomes more complex. And while modified GL systems can address many of the complexities of the process, these systems typically lack the flexibility in reporting and analysis required to meet the diverse needs of decision-makers at different levels across the enterprise.
Packaged financial consolidation and reporting applications have proven to be the best approach to solving the problem. By providing a high degree of out-of-the-box functionality, packaged applications can adapt easily to changing business needs, provide flexible reporting tools, and integrate quickly and easily with existing and new ERP/GL systems.
Lessons Learned
So, is the virtual close a myth or a reality? The virtual close is a reality, but it has thus far been adopted by only a small number of leading-edge finance organizations. Implementing the virtual close may require major changes in culture, business processes, and financial systems. The good news for companies is that by adopting many of the best practices associated with the virtual close – and by putting the right technology in place to support these best practices – companies will reduce reporting cycle time, deliver more timely information to decision-makers, and free up its finance staff to spend less time on processing and more time on providing value-added analysis to decision-makers.
Efficient financial reporting is key to comprehensive business performance management. Along with goal setting, business modeling, planning, continuous performance monitoring, and analysis efficient reporting improves a company's ability to spot business opportunities, allocate resources, and gain a competitive advantage in a rapidly changing marketplace.
