Robert Kugel's Analyst Perspectives

A Faster Close Fixes Other Accounting Issues

Posted by Robert Kugel on Jul 21, 2022 3:00:00 AM

Since its inception 20 years ago, Ventana Research has advocated for a shorter accounting close because it can improve the performance of the entire organization, not just finance and accounting. An important benefit of a shorter close is increased staff time for analysis and the preparation of reports and narratives that improve communications with the board and outside investors. Similarly, the department can provide those in operating roles the financial and managerial accounting results to highlight opportunities and issues they must address.

I also believe that uncovering and tackling the root causes of a too-long close will have a positive effect on a broad set of departmental processes. Our recent Smart Close Dynamic Insights research conducted in the first quarter of 2022 pointed to the need for a majority of organizations to address the issue of a too-long close.

The recent research found that 54% of participants (excluding those answering Don’t know) said it takes their organization seven or more business days to complete their quarterly close, exceeding the best practice benchmark of five days. This is up from 50% in our 2019 Office of Finance Benchmark Research. The percentage completing their monthly close in seven or more days was largely unchanged: 41% versus 40%.

A major objective in conducting the research was to assess the impact of office lockdowns over the past two years. There was concern among many in early 2020 that the inability to work together would cause substantial delays in producing financial statements and reporting results. Indeed, the U.S. Securities and Exchange Commission was concerned enough to give registrants carte blanche to request an extension, but as it turned out, almost none did.

Very likely, departments went to heroic lengths in the first half of 2020 to make deadlines. But the experience appeared to motivate accountants to embrace digital technology that enables them to operate with resilience under any circumstances. And our monitoring of the results of public and private software companies confirms that demand for software designed for the Office of Finance has been strong. At first glance, given the investments in software and the loosening of office restrictions, these most recent results are perplexing. But maybe they shouldn’t be.

Several hypotheses come to mind for the lack of progress on the monthly close and the regression on the more involved and complex quarterly close. A basic theory is that the department has been struggling to maintain the status quo over the past two years. Those that bought software to operate in a virtual environment were simply able to avoid falling behind, not improve performance in the monthly close.

And just buying software doesn’t necessarily produce immediate results. True digital transformation is achieved when processes are redefined and redesigned to take full advantage of new technology, and the people aspects of the transformation (chiefly change management and training) are addressed successfully. These – and the learning curve typically experienced with any change – may be important reasons for the lack of improvement.

The drop in the number of organizations able to close the quarterly books within six business days mirrored a pattern our research observed following the 2008-09 recession. Then, layoffs and shrinking staff resulted in organizations that made heavy use of manual tasks extending the close because there weren’t enough people to do the work in the same amount of time. Over the past two years, there were likely multiple factors at work, including resignations and retirements leaving the department shorthanded, or simply that the quarterly close is a more involved process that takes longer in a virtual environment unless all accounting systems and processes are overhauled.

For companies that take more than a week to close the books, shortening the close represents an opportunity to improve how well all finance and accounting processes are handled. That’s because the close is a useful benchmark of the overall effectiveness of a finance organization. Our research consistently finds that organizations with nearly identical characteristics – about the same size, compete in the same industry, operate in the same geographies, have the same ownership structure, the same number of enterprise resource planning systems and the same degree of centralization of the accounting function – can differ significantly in the time it takes to complete the accounting close. Common sense might dictate that having nearly identical requirements, resources and constraints, the two should close within the same interval. But dig deeper and there are likely one or more factors at work.

For example, in the case of the organization that takes longer to close, there is likely some combination of a lack of automation and, therefore, overly manual processes that are poorly executed, coupled with data quality issues that increase workloads by requiring excessive checks and manual reconciliations. It also may be a measure of the inability of management to get people to change, which is a consistent theme that I see thwarting attempts to improve departmental routines. Addressing the root causes of any of these challenges will not only help accelerate the close, but also – because these issues are likely to have a negative impact on other departmental processes – probably result in overall improved performance for all core finance and accounting functions.

Using practical and affordable technology to automate close processes is one intervention that is likely to help. Our recent research found that there is a significant correlation between the degree to which an organization uses automated workflows and the time to close: 69% of companies where most or all of the processes are automated are able to complete the quarter-end close within six business days. Compare this to just 29% that apply some or no automation.

Software workflows help guide process execution because they ensure all necessary steps are performed, all phases are executed consistently across an organization and the hand-offs between those doing the work are coordinated. Indeed, only 14% of organizations that are heavy users of workflows say that waiting for others to complete their work is an issue, compared to 40% where workflows are largely or completely absent. Similarly, 72% of companies that automate most or all of the reconciliation finish within six days, compared to 25% where some or none of that work is automated.

Shortening the close might also inspire broader attempts to improve finance department performance, including those that are the result of a complacent “we’ve always done it this way” approach. Using what Ventana Research calls a continuous accounting approach to managing the department can be an important element in shortening the close. Even something as basic as failing to rethink the process can lengthen the close. It’s not “cheating” to close subledgers before the end of the period, provided it’s done consistently and doesn’t inherently result in a misstatement. Balancing workloads during an accounting period is good management. Setting higher materiality thresholds for reconciliations can save a substantial amount of time without adversely affecting the quality of an organization’s financial statements.

A relentless drive to shorten the close also requires executives to rethink and question a lot of “givens” that routinely degrade their performance. “Relentless” means that it becomes a high priority that challenges a sense that “we’re too busy to improve efficiency.”

I advise every organization that takes more than a business week to complete its monthly or quarterly close to set a goal of reducing the time by at least two days over the next three years. If it now takes 11 or more days, the goal should be four fewer days. Making this effort is worthwhile for three reasons. Shortening the close enables an organization to provide vital financial and managerial information sooner, and it increases efficiency. Moreover – and possibly of even more value – the process of identifying the issues and bottlenecks that prevent a faster close is also likely to point to other issues involving people, process, information and technology that hamper the finance organization. Fixing the close process issue can be an excellent diagnostic tool for assessing anything else that might be holding back the department from better performance.

Regards,

Robert Kugel

Topics: Office of Finance, Financial Performance Management, ERP and Continuous Accounting, digital finance

Robert Kugel

Written by Robert Kugel

Rob heads up the CFO and business research focusing on the intersection of information technology with the finance organization and business. The financial performance management (FPM) research agenda includes the application of IT to financial process optimization and collaborative systems; control systems and analytics; and advanced budgeting and planning. Prior to joining Ventana Research he was an equity research analyst at several firms including First Albany Corporation, Morgan Stanley, and Drexel Burnham, and a consultant with McKinsey and Company. Rob was an Institutional Investor All-American Team member and on the Wall Street Journal All-Star list. Rob has experience in aerospace and defense, banking, manufacturing and retail and consumer services. Rob earned his BA in Economics/Finance at Hampshire College, an MBA in Finance/Accounting at Columbia University, and is a CFA charter holder.