Planning for a Faster Close – Are You Ready? by Gordon Tucker and Rachel Bell Protiviti

Planning for a Faster Close – Are You Ready? By Gordon Tucker and Rachel Bell Protiviti

Why Close Faster

With the advent of faster filing requirements by the Securities and Exchange Commission (SEC), U.S. companies have an added reason to speed up the financial close process. Consequently, increased attention is being paid to this important area.

In September 2002, the SEC published rules that phased in quicker filing deadlines for companies submitting Forms 10-K and 10-Q. Though several modifications and postponements had been made since the original rule, companies must still file more quickly than in years past. Current filing deadlines are: 10K 10Q Large Accelerated (public float of more than $700 million) 60 days 40 days Accelerated (public float of at least $75 million but less than $700 million) 75 days 40 days Non-accelerated (public float of less than $75 million) 90 days 45 days

While the new filing requirements provide a strong incentive to improve the close process, even without the extra push from the SEC there are good reasons for companies to improve their financial close process. A more efficient process gives companies more time to prepare for earnings releases, review and analyze financial statements to avoid the possibility of material misstatements, and possibly cut costs associated with the close process by reducing the number of internal and external reviews of Forms 10K and 10Q.

The extra time means companies have a better chance to more thoroughly script the press release with investor relations and prepare for the earnings call with analysts. This is becoming increasingly important because of the greater scrutiny of financial reports in recent years. While cost reduction is sometimes possible, the main benefits of a more expedient close process are the ability to spend more time preparing communications and analyzing data before releasing it.

How others are doing Many companies struggle with aspects of the close process. Unexpected and unknown bottlenecks often occur. The challenge can be particularly great at smaller and mid-sized companies that lack the integrated automation and depth of skilled resources typical at larger companies. But larger companies can also experience difficult period-end closes, particularly if they are geographically dispersed or organizationally complex.

A survey published by Ventana Research in September 2005, involving 200 finance and line-of-business employees at large companies, found that a majority of them, more than 60 percent, are closing the books within six days. This isn’t surprising, as large firms tend to have a higher degree of financial systems automation and integration. Because of the coordination effort required to effectively manage data from a variety of different sources and locations, larger companies also tend to apply a stronger routine with more discipline around deadlines.

In examining a cross section of 30 of the San Francisco Bay area’s Top 200 companies, nearly two-thirds of them failed to file their 10-K within the revised 60-day period. Consistent with the other survey, it was most often the largest companies that achieved the 60-day deadline.

Common hurdles There are many reasons companies have trouble speeding up their close process. Common reasons we have seen with our clients include:

• Disparate non-integrated systems • An excessive number of systems feeding into the general ledger • Lack of resources or unqualified people performing the close of books • Extensive use of manual controls • Sarbanes-Oxley testing activities • Poorly defined close and filing schedule • Weak commitment in the organization to meet deadlines • Difficult corporate consolidation, often a result of a large number of legal entities, both foreign and domestic • Large number of manual journal entries • Late account reconciliations • Redundant internal reporting packages that coincide with the close

A good way to determine whether your company has an opportunity to improve its close process is to ask a few basic questions, such as:

• How does your company define “close”? When the general ledger is complete? When the earnings are released? When the financial reports are filed? • How many days does your company take to close the books? • Does your company use a close calendar? If it does, are tasks prioritized and are deadlines consistently met? • Where are finance personnel spending most of their time? • How long does the finance department take to complete the tasks listed on the close calendar? • Is enough time allocated to significant tasks? • Where is time lost and why?

The answers provide the best starting point for determining where and how to make improvements to your close process.

Some leading practices Significant progress can be made by first implementing a clearly defined and detailed closing schedule and communicating deadlines to everyone with a hand in the process. This is true regardless of company size. Companies that employ a well-planned close schedule and strictly adhere to it can mitigate bottlenecks or surprises.

Companies that do a good job with closing the books also tend to:

• Begin account reconciliations and analysis outside the close cycle, to the extent possible. • Establish a “pre-close meeting” early in the close cycle to discuss any unusual results with management and any potential issues that could impede the close. • Limit the number of general ledger trial balance runs to two. • Automate recurring journal entries. • Automate allocation and consolidation processes.

• Incorporate estimation techniques in non-quarter month-end closes. • Set materiality tolerance limits for adjusting journal entries. • Simplify the structure of the general ledger, with as few general ledger accounts and cost centers as possible. • Close inactive accounts and cost centers on a timely basis. • Use exception reports. • Use integrated systems that directly link sub-ledgers to the general ledger. • Use analytical software tools that are linked to the general ledger to minimize manual data entry and facilitate the preparation and issuance of management reports. • Use EDI data transmission over dedicated lines. • Use key performance indicators measuring quality, cycle time and cost.

The more of these practices a company can employ, the better off it will be. But the biggest impact comes from performing as much of the account reconciliation and analysis as possible before period-end. Companies should abandon the idea that close activities do not start until the end of the month. While it’s often not possible to fully complete reconciliations prior to the close, earlier transactions for many accounts can be reviewed and analyzed beforehand so that less time is spent on any final reconciliation activity required during the close. These pre-close activities should be outlined in each company department’s detailed close schedule.

Using a close calendar A comprehensive close calendar will outline the detailed tasks, related reviewers and specific due dates for each staff person involved with the close. Moreover, the calendar will have applied priorities to ensure personnel are completing the most important tasks first. This promotes efficiency and alleviates bottlenecks.

A close calendar is not just for the accounting department. Each department involved in the close, as well as external parties (e.g. external auditors, external law firms), should have a calendar. A good practice for any department involved in the close is to prepare the detailed calendar for each month at the start of each fiscal year.

Pre-set, routine close meetings – or “stand-up” meetings – before and during each close can help ensure everyone is prepared. Discuss any potential bottlenecks, and investigate unusual results as a group to identify their cause. Cross checking explanations of results among parties responsible for different areas of the financial statements can be an efficient and effective way to detect potential recording issues early.

Once a department has established a detailed close calendar, it is well on its way to being able to identify potential areas for improvement. Tracking and evaluating whether each staff person has been able to meet deadlines not only promotes a culture of discipline, it also allows the department to understand whether the dates are reasonable. Some deadlines could be moved up. Other tasks could be afforded more time.

Tracking completion of the close also helps with the analysis of why some tasks are not completed on time. Sometimes the delay can result from the domino effect of one task finishing late and affecting others. In another case it could be the sheer volume of work required to complete the task. This can be very common in tasks that are manual and iterative, requiring detailed checks to ensure their completeness and accuracy. The level of effort for these tasks often depends on the volume of data to be processed or analyzed, which can fluctuate from period to period, making it difficult at times to determine an appropriate due date.

Moreover, by tracking task completion, a company can begin to isolate and prioritize those tasks that could benefit most from the automation or process improvement suggestions made earlier under leading practices.

A disciplined approach At one smaller company we recently reviewed, the primary cause of missed deadlines was the lack of a comprehensive and well-designed close calendar. The company also lacked a disciplined approach to closing its books. By getting help to develop a close calendar, establish close meetings, measure completion of tasks and ascertain the causes of delay, the company was able to quickly pinpoint the areas that created bottlenecks and inefficiencies.

Some of the results in this review were startling, especially to the head of the finance department, who learned that one accountant was spending nearly half the month reconciling one account. This caused other tasks to fall by the wayside. This and other findings convinced the company of the need for a better outline of tasks. The company also saw the need to communicate those tasks to all those involved in the close process.

The company now has a detailed close calendar and uses its regular close meetings to measure progress throughout the close cycle. As the company gets better at consistently meeting its close schedule, it will be able to make incremental improvements that provide more time for data analysis and financial statement preparation.

What is the right number of days to complete the close process? That will depend on each company and its goals. The faster a company can close its books and prepare financial statements, the more time it will have to ensure there are no material misstatements and to prepare for the earnings call.

The most important questions to ask are: Do you understand your current scheduling? Have you captured, prioritized, and assigned all required tasks? Are you hitting your deadlines? Do you know why if you’re not?

Let your close calendar help you find the answers.

Conclusion In the end, a disciplined and timely close process will not only aid compliance with filing requirements but also lead to higher quality, more accurate reporting. It will also provide for stronger controls over financial reporting – which are critical to demonstrate in today’s world of Sarbanes Oxley compliance. Finally, a well managed and optimized process gives the finance team time to add more value as a strategic partner to the organization.

Gordon Tucker is a managing director at Protiviti with over 20 years experience providing internal and external audit and consulting services to High Technology and Manufacturing companies. His client responsibilities include developing annual risk assessments and executing global internal audit plans, assessing and implementing finance process improvements, consulting with CFO’s, Executive Management and Audit Committees on corporate compliance and governance requirements, and overall project management.

Rachel Bell is a Director in Protiviti’s San Francisco office, focusing on internal audit and business risk consulting, along with delivering services related to compliance with the Sarbanes Oxley Act of 2002. Rachel has more than twelve years of experience providing business assurance, management consulting, and internal audit services. Previous to Protiviti, Rachel was a Principal Consultant in PricewaterhouseCoopers Management Consulting Services group specializing in organizational and process improvements around finance functions.

Protiviti is a leading provider of truly independent internal audit and business and technology risk consulting services. We help clients identify, measure and manage operational and technology-related risks they face within their industries and throughout their systems and processes. And we offer a full spectrum of audit services, technologies and skills for business risk management and the continual transformation of internal audit functions.

Protiviti is not licensed or registered as a public accounting firm and does not issue opinions on financial statements or offer attestation services.

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