The Accounting Cycle and Business Decisions

Posted on Jan 21, 2011 in Articles, Cash Management, Finance, Management

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When we think of a business, we must think in terms of activities that produce resources and those that use resources. Everyone and everything in the organization is engaged in creating or consuming resources, or in some instances both. People who are paid for their services are a use of resources, but these same people may engage in activities and create processes that will either generate sources (sales, assets) or consume the resources (e.g., manufacturing, accounting, marketing). Some activities consume resources but are processes that assist in generating resources, such as marketing and sales.

Finance and accounting can be established to provide different types of information, the value of which varies based upon the user’s purposes. A successful accounting system must be able to generate relevant and timely information for taxes, payroll and other compliance reporting related to taxes. This structure of reporting is not usually of benefit or meaning to the internal users of financial and accounting information, who typically need to know things on the basis of decision-making impact, e.g., “Should you do project 1 or 2? Did the marketing campaign generate the target revenue increase? Did the department go over budget and if so why?”

The Numbers In Perspective

As a business there are multiple stakeholders looking to the “numbers” for different information. The ability to generate relevant, timely, and informative financial information is a critical aspect of engaging the “non-financial” managers in the process. From a business perspective, every manager is part of the financial and numbers game. Some managers are trained in finance and accounting and are responsible for the reporting of results. Other managers are users of the information and through their activities generate the numbers, the “score card” of the game. Winners and losers are determined by how well relevant financial information is used to make decisions for the short term and the long term.

 The Score Card: A History of Organizational Performance

Financial statements that are produced are the history of the organization, e.g., how decisions already made are playing out. With timely information corrective actions and changes in activities can be implemented to impact future results. Other tools like budgets and forecasts are created to impact and direct future results. The budget, the actual numbers and the forecasted numbers are three components of managing the organization’s results well.

Financial Statements as Performance Indicators

However, numbers cannot be the sole determinant of a company’s performance. The numbers must be prepared, traced, and attached to meaningful measures that are in themselves set through reasoned judgment, sound strategic thinking and with a long-term objective mind.

When an organization examines its operations through the numbers, it is possible to quantify what the business has done and has yet to accomplish. When the numbers are organized and stratified in a manner that enables the company to attach numbers to activities, processes, projects and products, as well as to customers, operational units and individual performers, then they become true indicators of the sources and uses of cash, revenue and profits.

The budget and forecasted performance are mechanisms for improving results and for benchmarking expectations to enable the organization to act rather than react to changing circumstances including competition, the economy and internal structure and demands. Organizations need to set direction by the budgets, be guided by forecasts and measure by results that are not only tied to the bottom line but also valued by milestones and deliverables measured by how much each cost to achieve versus plan.

Profit is fine as a point-in-time measure, but the reality is that profits generated today may be a result of making a decision that will in the long term impair the profitability and viability of the organization. A good example of this is the mortgage industry, in which higher risk loans were made to pump up the results of current operations (and profits) with a knowledge that the loans may in the long term not be repaid. While not everyone who participated in the mortgage debacle ended up reaping the consequences, everyone did become aware of just how damaging it can be for the focus to be solely on today’s metrics (e.g., profits, stock price). Every day, somewhere in the world a business or organization suffers the consequences of thinking only of today and not the long-term ramifications. For every entity that fails another will step up to fill the void and hopefully understand the tradeoff between managing near-term projects and operations with an eye to the long-term strategic and financial results they want and need to achieve.

The numbers are key indicators for what the organization is and isn’t doing. Lack of detail and visibility to decision-making and the results tied to decisions often leads management to new decisions based on what little they can “see” versus the clarity of results from managing by the numbers and with clear relationships between actions and strategic goals.

 Author:  Lea A. Strickland, MBA CMA CFM CBM GMC
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