The 3 building blocks of Financial Management

Well managed companies employ many tools to optimize financial performance, some of which can be very sophisticated. However, most of these fall within the basic “blocking and tackling” of financial management.

Invariably, entities that underperform or experience fraud or some other impropriety will have failed in at least 2 of these categories. And the price of failure can be harsh. Many companies when they experience a negative event — a fraud perpetrated by an employee or a significant misstatement of their financial statements may be forced into bankruptcy or may be forced to merge or restructure against their wishes.

So reflect on your business operations and determine if you are lacking in these areas.  If so, take quick, calculated action to supplement the areas of internal control, financial reporting and financial monitoring.  The 3 pillars are:

Accurate, detailed financial statements produced in a timely fashion

Management should see to it that financial statements and management reports are produced in a relatively timely fashion. If your accounting staff cannot produce meaningful reports in a timely fashion or if the information is inconsistent or contains many errors, you could have a serious problem.    If erroneous data has to be furnished to outside stakeholders like bankers, auditors or joint venture partners, you may lose credibility or may incur financial losses directly attributable to the loss of confidence of your stakeholders – such as the closure of a debt facility. You should ask yourself these questions:

Is the financial data contained with reports consistent? Does it dovetail with what you know is happening with the business? Does it allow you to conclude on opportunities and exposures?

Are you able to answer relatively simple questions such as what has led to an improvement or deterioration in your business over time or what is the biggest contributor to operating profit?

Adequate internal controls including adequate segregation of duties

Early in my career, the audit team that I was managing discovered a fraud at a location outside of the US. We couldn’t reconcile the general ledger to supporting data. We discovered a multimillion dollar fraud by a lower level accounting employee.  The fraud was possible because the entity used manual checks instead of computerized checks (management didn’t want to switch because computerized check stock was more expensive than manual check stock).  The thief was responsible for writing checks by hand and would make phony checks to real vendors and would then obtain the necessary 2 signatures from senior management. He would then alter the checks so that he could have a family member cash them. He reconciled the Accounts Payable subsidiary ledger (an inappropriate duty coupled with check writing and expense voucher entry) so he was able to cover up the fraud for several years.

Does your business have adequate controls and procedures in place to prevent errors and irregularities?

Do the proper checks and balances exist so that one employee does not have an undue level of access or control? What controls and procedures are in place to prevent an employee from making an unauthorized disbursement by check or wire transfer? What prevents an employee from setting up a phony vendor or phony employee in your computer system?

Proactive, well informed, inquisitive management

The most valuable asset to a small business is astute management that asks the right questions, has a strong vision and is able to capitalize on opportunities quickly and efficiently. This type of management will use the solid financial data at their disposal to determine where their business is headed, to change course and/or speed and use all their resources to get to their destination. But management will need to be able to “mine” data to determine how the business is doing and why? Which clients are profitable and which are less so? Which products generate the highest gross margin and which contribute little? How are the trends in your business versus competitors of a similar size and make up? How do you position your business for a trade sale and how do you modify your business to give rise to a higher purchase price from an acquirer?

But talented management will need timely, reliable financial data produced in a strong control environment to be really successful. Otherwise, you will be making decision and determining a course that might not be the best one.

If your management is not able to be really proactive, to gain the knowledge that they require from management data and to be truly inquisitive, you may be incurring serious exposure due to poor performance in financial management.