How Can a CFO Establish Formal Closing Procedures?

Dear CFO,

I am the CFO of a mid-sized manufacturing company with three divisions. I am required to have “final” numbers to Senior Management by the 5th workday. It’s like pulling teeth to get the required information from everyone involved. I’m the one who looks bad when the numbers are late. How do I get the accountability without much authority?

Tired of the battle, Scarsdale, New York


I can empathize, having been in a similar situation. In my case, I was at Corporate and the division accounting people reported up through the division presidents; therefore, I had no direct authority to address the problems. Our issues included those stated in your question, as well as having to correct the poorly made journal entries (this was before the existence of auto-balancing and account verification within systems). That being said, the underlying problems were the same–all the accountability and none of the authority. This is a common delegation trap: where someone is given responsibility without the tools to complete it properly.

In my case, with the approval of the CEO, I took two actions to solve the problems (as I’ll outline below).

If you notice issues in the closing procedures, you may need to get involved with higher management to implement more effective procedures.
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Why should you get management involved and why should they care? While a CFO or Controller may drive the closing procedure and checklist, it’s done on the basis of establishing complete and accurate financial statements for all upper management decisions. The responsibility, as well as the need for accurate numbers, is companywide.

Good data (financial and other) is costly to accumulate and verify, but even more costly to correct; not to mention the cost of making a bad decision. Let’s say it costs your staff 10 hours to validate the KPI’s and financial data and the average pay is $40/hour, so the validation costs $400/month or $4,800/year.

Correcting that same data costs $48,000 and a single (just one!) corrective action is $480,000 under a data quality 1-10-100 rule first proposed by George Labovitz and Yu Sang Chang in the 90’s. Whether this rule holds or not, you can see bad data is very expensive and avoiding errors important.

Establishing Formal Closing Procedures and Checklists

After discussing our late closing issues with the division heads, I found they were having the same problems within the division. Information they needed wasn’t submitted in a timely manner and occasionally, it was also submitted inaccurately. They too suffered from facing responsibility without having enough authority. Oh… What to do?

A root cause of the problem was a lack of clear definitions of who was responsible for what task and in what timeframe. They needed a clear checklist and outlined formal closing procedure. It had to be written out and easy to follow, reference, and understand. While the initial process of establishing the formal closing procedures and checklist might seem tedious, the speed and accuracy of the monthly financials improves dramatically once the procedures are implemented.

Establishing a clear list of requirements, timeframes, and most importantly, responsibility cures the problem and eliminates finger-pointing. The checklist should include not only the process of the close but also the needed reports (exception reports) that identify where to look for problems. Each department in the company typically has some responsibility for “close” data, even sales. While there is a presumption all data is entered in a timely fashion (and we know that doesn’t always happen), implementing a clear formal closing procedure for the month’s end assures information needed for management decisions is complete, timely, and accurate.

The key to eliminating delay and implementing a successful formal closing procedure and checklist free of inaccuracies is getting buy-in from those in authority. Management must agree that the people identified are responsible and held accountable for accurate information submitted by the due dates established.

Setting Up the Formal Closing Procedures and Checklists

To set up the closing checklist, begin by thinking of all the roles in the company that affect the financial statements. The objective of the closing checklist is to collect complete information timely and accurately. Another benefit of the closing checklist is the opportunity for confirming internal controls (more about that subject in a future blog). The point is: think broadly.

  • Do sales reports reflect quotes that convert to invoices? Who does the conversion and how do they know that it’s time to invoice? What must happen to make sure these invoices are complete?
  • Are materials ordered directly by production or purchasing? How do you know if the orders are received and/or if the expenses are properly applied to jobs?
  • Does the warehouse record inventory ins and outs, as well as the counts accurately? How can you validate that the counts? Do you see any negative balances? Is the amount of the count out of line with previous adjustments?
  • Was all cash properly applied to accounts receivable? Are the number of credit memos appropriate? Has aging changed?
Here is a sample closing checklist.

 

Establish Needed Reporting and Analysis

Once formal closing procedures are established and reports begin to flow in more accurately, analysis is needed to determine the effectiveness of your new procedures.
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Once you’ve thought of the actions that feed the financial statements, identify the reports that would quickly identify issues. Exception reports identify variances from expected outcomes. There’s no need to identify and review every transaction. Identify how exceptions occur and then look for them. For example, unconverted orders over 30 days may flag a missed billing. However, in a company with manufacturing lead times of 6 weeks, the criteria may be orders over 45 days.

There is analysis and evaluation associated with reports, of course. The person analyzing the report should be the person closest to and/or responsible for the information. Measuring against benchmarks (KPIs) identifies issues and measures performance. For example, if the unconverted order is 60 days past due, the production manager may be aware of a problem obtaining special materials. (This should raise other questions on management broader than this blog.)

Assign a Due Date on All Information

Due dates are dependent on two factors: when information is available (or estimated) and the due dates of the subsequent reports. Often calculating the dates is a matter of backtracking the “need” for financials. I believe the objective should be to get the financial statements as soon as possible, preferably within 2 to 3 business days. While many modern accounting systems seemingly calculate in real time, the reality of the business process still requires some, albeit not significant manual intervention. Due dates usually reflect workdays.

Assign Responsibility for the Closing Checklist

Responsibility is NOT generalized at the department level – it’s assigned to a specific PERSON. This assignment of responsibility and accountability is part of establishing a strong, positive company culture. As Harry Truman said, “the buck stops here.” Or the more modern, “if it is everyone’s job, it is no one’s job.”

If the VP of Purchasing knows the most, then that is the person on the closing checklist. Always assign the person closest to the project as the responsible party for formal closing procedures.

Consequences Should Fall on Those Who Don’t Perform

Are your employees not performing their duties? Consequences should fall on those who don't perform - make sure your employees understand their responsibilities so that all tasks are covered.
Image via Pixabay

As I mentioned above, I had a similar problem with getting information for my company’s month-end closing. My department, as the last step in the process, was typically staying late every month attempting to correct and gather data not properly submitted. We were visible to senior management and had responsibility for corporate reporting.

It didn’t take long for me to realize, one of the reasons for non-performance was that all the consequences were on my department. The employees who submitted poor information were gone at 5 o’clock, while we stayed late to pick up the pieces. After attempting (and failing) several times to resolve the issues and encourage proper information, I had to take drastic action. Again, with the approval of the CEO and the Controller, we decided to let the chips fall where they may.

The result was chaos, but only once! When the division financials came out none of them bore any resemblance to reality… and then the phone calls started. I had a call from each of the division presidents within 10 or 15 minutes of issuance. I calmly explained I had processed the information their division submitted. Suddenly the lights went on! With clear, formal closing procedures implemented, everyone was held responsible for their department’s missing information and the gaps became clear.

As a result, the presidents started taking ownership of their individual divisions. And yes, when the division leadership started to hold their teams accountable our lives became easier (even if we still didn’t leave at 5pm, especially at the end of the month).

Implementing these formal closing procedures and the checklists will not only improve the experience of your team, but will provide consistent, accurate financials enabling timely decisions and accurate trending for decision making. Come month’s end, you won’t be pulling teeth to get the numbers you need to close your reports.


Featured image and post images licensed for use via Pixabay.

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