CFO series – the foundations of effective management reporting
For effective management reporting from a CFO’s perspective, we believe there are 3 foundational ingredients:
- Attention to transactions – setting up for success
- Benchmarking and analytics – refining performance
- Forecasting and budgeting – strategic thinking
This is the first of our 3-part CFO Series where we explore the first foundational ingredient:
Attention to transactions = setting up for success
| “All Good to Great companies began the process of finding a path to greatness by confronting the brutal facts about the reality of their business. When you start with an honest and diligent effort to determine the truth of your situation, the right decisions often become self-evident.”— Jim Collins |
Detail matters. As a CFO, it is your responsibility to be custodian of the accuracy of information you’re basing decisions upon. That doesn’t mean you need to be buried in the detail personally however you need to make sure someone or people are attentive to transaction level detail.
A – Nature
Attention to the nature of transactions is fundamental in enabling highly effective management reporting. High quality and accurate transaction disclosures via bookkeeping is essential, ensuring transactions are allocated accurately and appropriately.
Examples
- For example, an entertainment cost is mutually exclusive to a client gift (or a non-entertainment) expense. They may be considered the same by some businesses, however they’re not. If you’re giving a gift to a client for a particular purpose, that’s different from taking a client out for lunch. The tax nature is distinguished in this instance and understanding these finer points matter.
- Capital expenses – another typical transaction which is commonly misallocated and misunderstood relates to capital items/equipment. People often assume that buying a capital item is an expense, and they record it directly to an account category such as printing, stationery, repairs & maintenance or office expenses as opposed to reporting that computer or printer (for example) as an asset, which has a different reporting and tax profile. Those costs are also viewed in a different capacity by lenders and business investors. Depreciation of capital items is generally an add-back item when analysing a business’s earnings which improves the interpretation of numbers for these critical stakeholders. The inaccurate recording of such transactions distorts the analysis of a business.
Nature of transactions is one of the most important focus points of an effective CFO and the reporting they are able to produce for their business.
Ancillary details
Ancillary transaction details are another form of detail orientated improvement and focus for an effective CFO. Due attention should be paid to ensure all details around the transaction are recorded appropriately, such as customers’ descriptions, references, dates, job, or project numbers etc. Any effective accounting system should enable you to report based on a broad spectrum of ancillary details (i.e., customers, products, divisions, dates, references etc). The more details you can extract from a transaction, effectively and efficiently, for disclosure within your systems facilitates better management reporting.
B – Tax (GST, Fuel Tax Credits, Income Tax and Fringe Benefits Tax)
From a holistic tax perspective, transactions need to be correctly allocated to enable the appropriate claim of or payment of taxes. This is tax compliance 101 and is an essential part of effective management reporting. We have been historically astounded as to the quantum of misallocations in relation to tax on transactions. We have identified issues and saved our clients tens of thousands of dollars, on a reasonably regular basis over the years.
Examples
- Insurance – a simple example of a misallocation is in relation to insurance where often 10% GST is taken up on all insurance payments however there is usually a GST free (stamp duty) component to these costs. This may not have an impact on smaller transactions, however they aggregate over time and across the board with various insurance categories (i.e. public indemnity, public liability, professional indemnity, motor vehicle, income protection, keyman, business disruption and continuity, office/premises etc.)
- Export sales – a more uncommon and complex misallocation relates to export sales. Export sales, which are principally goods and services delivered overseas, are GST free. We have had two clients in recent years save over $50,000+ each through our identification of errors relating to these GST disclosure items. It’s not a straight forward area of indirect tax, but the CFO of your business (i.e. you?) need to know this, or have a suitable adviser overseeing the technical proficiency you may not have.
C – Transaction Categorisations
Level 1: Generic Categories – Revenue / Expenses
An effective enterprise should ensure its generic transaction categories are considered and tailored for the benefit of effective management reporting. Your trading revenue should have trading revenue transactions in it only, not to be confused with non-trading revenue items such as interest income, FBT contributions, government grants, or gains/losses on sale of assets, which are all non-trade related sources of income. The same applies for expenses. For example, for a building business, concrete and labour on site are direct costs and must be categorised as such, whilst an office administrator and rental premises should be categorised as an overhead expense.
There needs to be a clear distinction with how transactions are categorised to enable an accurate understanding of key performance indicators such as headline revenue, gross profit, gross margin, EBIT/EBITDA, net profit etc.
Level 2: Specific Categories – Industry / Business
A next level of detail with respect to transaction categorisation relates to those which are business or industry specific. For example, marketing spend may be an overhead for some businesses but a direct cost for others. If you are selling a product, then marketing that product is a direct cost of sale. However, if you’re a service-based business, then passive brand marketing with no intention of direct sales is an overhead. Each business needs to understand its objectives and how to specifically categorise transactions.
Level 3 – Tracking and Segmentation – Projects / Divisions
A deeper level of transaction allocation relates to tracking or segmentations. Examples include the following:
- Projects – income and expense transactions can generally be tracked to a particular project within accounting software. Every business has projects and understanding project performance is critical to successful management reporting to help drive business decisions.
- Business divisions – should you have multiple business division, transactions can (and should) be categorised and allocated to those divisions, facilitating effective reporting which enables enterprise leaders to better analyse divisional performance.
- Discretionary v essential – whether you’re doing well or not, it’s prudent to analyse and/or understand costs that are essential versus discretionary in order to cut back on discretionary spend as required.
Want to learn more? Stay tuned for Part 2 of our CFO Series: Benchmarking and Analytics – Refining performance, as we address topics such as time-based comparison and trend analysis, benchmarking and comparisons along with exception analysis and enquiry.