Avoiding the Top Three Costs of End of Month Urgency
And upon the dawning of the month, the accounting multitudes did answer the call of thy most holy journal entry gods, and for seven days and nights did prostrate themselves upon the alter of the general ledger ...
In many organisations the financial close at the end of the month (EOM) has all the hallmarks of ancient ritual. To those steeped in the tradition of the financial period close, a five to seven-day period of apoplectic behaviour seems natural, though the rest of the organisation sees only a bizarre display of chaos, inefficiency and disruption.
Although the financial close is a necessity, the atmosphere of urgency that surrounds it is not. In this article I will describe the top three costs of EOM urgency, explain how these regular periods of hysteria can be avoided, and show how firms can benefit from a positive feedback loop between prospective and retrospective assessments of financial performance.
The Cost of EOM Urgency
The costs incurred as a result of rushing the financial close are mainly hidden, and for the most part fall into one of three categories:
Avoiding the Panic
The justification for rushing the period close is to enable the firm to access information from its financial systems as soon as possible. The urgency of EOM can therefore be avoided by having, in advance, a dependable set of estimates of the same information. In other words, by reliably forecasting monthly financial results.
If we already have a picture of the firm’s financial position, and we can be confident that it’s reasonably accurate, we don’t need accountants turning themselves inside out to tell us what we already know. Instead, the accounting team can take their time to produce a more diligent assessment of the firm’s financial position, and maybe tell us something we don’t know. A diligently prepared and accurate set of retrospective financial statements is a valuable thing in itself, but we can also use it to calibrate our forecast model and continually enhance our forecasting capabilities.
The approach I am advocating requires firms to place higher reliance on forecast results to manage the here and now. The most common objection to this shift in focus is that “it’s only a forecast”. And yes, it is “only” a forecast – one representation of a firm’s performance and financial position. But this is exactly what so-called “actuals” are – one representation from among an infinite number of alternatives. The fact that actuals take a retrospective viewpoint is not, by itself, a reason to assume they provide a more accurate assessment than a prospective view. Actuals, as the saying goes, are not very actual.
In the short term, forecasts will generally provide a more useful set of financial statements than actuals. This is because actual financial statements tend to be noisy. When I say noisy, I mean they are heavily influenced by meaningless information such as random events, arbitrary timing decisions, and errors. Forecasts, on the other hand, are pure signal. And although forecast models are subject to systemic error, these can be quantified and gradually corrected – provided we can rely on the long-term signals from the actuals.
Not only will a reliable forecast reduce time pressures at EOM, it can also provide a sense-check for the actual results. If a significant difference arises between actual and forecast results, investigation will probably reveal an unforeseen event. But it might also uncover an accounting error in time to correct it. I recently produced a forecast for a client that predicted significantly lower payroll liabilities than those which subsequently appeared during preparation of the actuals. Investigation revealed that the final payroll journal for the month was often incorrectly posted to the following month, and sense-checking preliminary results against the forecast identified the error. So while reliable actuals are used to calibrate and improve forecast models, reliable forecasts can guide the preparation of actuals. It’s a win-win.
The EOM routines observed by most organisations are expensive and disruptive. Enhancing the firm’s forecasting capabilities can remove the urgency from EOM processes, freeing up resources and paving the way for more diligent and accurate assessments of financial performance and position. This approach can set up a positive feedback loop between prospective and retrospective assessments of financial performance, with trusted actuals guiding the improvement of forecast models, and reliable forecasts serving as a sense-check in the preparation of actuals.