Sorry, Wrong Number by KBRG

Sponsored by

Sorry, Wrong Number Meeting the demand for error-free financial reporting

Scholars say making mistakes is one of humanity’s defining characteristics. Ray Panko, a professor of IT management at the University of Hawaii, has estimated that when human beings perform any complex logical activity, people can be relied upon to make a mistake about 5% of the time.1 Even in the digital age, errors remain a significant cost of doing business. Whether caused by a misplaced keystroke, faulty accounting, bad coding or deliberate fraud, inaccurate financial results are still surprisingly common, and to an extent, ubiquitous: In seven studies of field audits conducted over a 13-year-period (1995-2008), investigators found that 88% of the operational spreadsheets they sampled contained errors.2

The costs of getting it wrong

Financial errors can be extremely expensive, especially when they lead the company to make a bad business decision or issue an improper forecast. From the 2007-2008 financial crisis until now, inaccurate or inadequate numbers have played key roles in many of the larger financial debacles: • In analyzing the roots of commodities giant MF Global’s collapse in 2011, bankruptcy court investigators concluded that the global trader had insufficient insight into its own operations. According to the investigation report for this case: “MF Global’s collapse was abetted by, among other things, management’s failure to integrate or upgrade its various technology systems and platforms for monitoring Treasury Department operations, liquidity risk, and financial regulatory functions.”3 • An internal investigation of JP Morgan Chase’s $6.2 billion trading loss in 2012, the socalled “London Whale,” revealed that the risk model used by JP Morgan’s traders “operated through a series of Excel spreadsheets, which had to be completed manually by a process of copying and pasting data from one spreadsheet to another.” As a result, JP Morgan analysts believed their derivatives bets were half as risky as they actually were.4 • In September 2014 Tesco, the British grocer, released its third profit warning within three months when it announced that it would be £250 million pounds short of its latest profit forecast, a 23% disappointment. Tesco executives had booked income from suppliers earlier than they should, while also delaying booking their costs. One retail analyst concluded that “the only way Tesco could have ‘delayed booking of costs’ is by not entering invoices into its accounting systems. In today’s world of electronic invoicing, that’s not easy to do and had to be consciously managed.”5 Ray Panko, “What We Know About Spreadsheet Errors,” Journal of End User Computing, volume 10, No 2. Spring 1998, pp.

15-21, Revised May 2008.

2 Ibid 3 Report of Investigation of Louis J. Freeh, Chapter 11 Trustee Of Mf Global Holdings Ltd., Et Al. United States Bankruptcy Court for The Southern District of New York, April 2013.

4 “Damn Excel! How the ‘most important software application of all time’ is ruining the world,” Fortune, April 17, 2013.

5 “Tesco’s Accounting Irregularities are Mind-Blowing,” Paula Rosenbloom, Forbes, Sept. 22, 2014.

1

Karlo A. Bustos CEO & Chief Analyst M: 617.898.7476 E: kbustos@kbrg.co l www.kbrg.co l

1

Mitigating Financial Errors While Providing Actionable Reports

|

|

Sponsored by

Technology mitigates risks

The persistence of human errors is puzzling in some ways; because over the past 30 years, the ability to catch mistakes has improved dramatically.

“Better software has made it more difficult to make a serious mistake,” says Bruce Kelly, Senior Director at Alvarez & Marsal, a leading global professional services firm. For example, he says, embedded logic can now send out an automatic alert when an expected value doesn’t fall within an anticipated range. This capability allows companies to be proactively notified of potential problems so they can be addressed before serious harm is done. But software hasn’t completely eliminated the risk of major errors.

“Most ERP packages have features that can prevent issues like duplicate vendors, but they don’t catch mistakes like purchase orders that are entered multiple times for vendors with similarly spelled names,” warns Suzanne Wilt, Senior Director, Industry & Financial Solutions Strategy for enterprise software vendor Infor. “Errors also turn up when payments are processed through separate platforms or out of some distant office. The question is: how are you proactively monitoring for things that circumvent the normal? Whether it’s collusion or a mistake, you must be able to catch it.”

One technology that can help is continuous monitoring, which allows companies to automatically monitor all transactions – a task that cannot be undertaken using manual means.

“The goal is not to detect trouble but to prevent it,” explains Wilt.

Companies that use this technology report that it has helped them eliminate thousands of potential errors and accounting pitfalls: • Textron, a complex $11.3 billion global manufacturing conglomerate, eliminated thousands of control violations, significantly reduced the time and cost to support its external audit, and automated the monitoring of key controls.

• With over 149,000 employees working in 20,000+ stores in 60+ countries, Starbucks faced a huge challenge in transactions monitoring. North American operations alone required 1100 manual controls. Automation eliminated the need to prepare reports and gather information manually in advance of and during audits. Continuous monitoring software also automated requests for user access to the company’s ERP system to help prevent control violations.

• Alcatel-Lucent is a leading innovator in the field of networking and communications technology, products, and services with approximately 76,000 employees worldwide.

Prior to implementing CCM technology, they were challenged with recurring audit and compliance inaccuracies. Since implementation, not only have they been successful in executing controls monitoring across multiple business units and geographic locations, but they have nearly eliminated user access control violations, reduced audit costs and increased employee confidence in compliance.

Other advances in software development are helping companies solidify their numbers. Some cutting-edge organizations find that they can guard against errors in their financial forecasts by calibrating them against nonfinancial data. For example, at the American Academy of Physicians’ Assistants (AAPA), the finance team now integrates social data structured in Hadoop into its financial forecast. “This kind of integration can make [the forecast] more solid, because your projection is based not only on what the department head says but what your customer experiences,” explains Shyam Desigan, who was until recently the group’s Chief Financial Officer and Sr. VP of IT. He is now VP of Finance (Healthcare services and HCIT portfolio) at KIC Ventures Management Group in Boston.

2

Mitigating Financial Errors While Providing Actionable Reports

|

|

Still the weakest link

But human beings are unpredictable. Even with all these new guardrails, a few will still manage to run off the road. In fact, some experts speculate that technology may be creating new opportunities for errors. Before automation, there was much more manual oversight of financial processes, and financial officers were closer to the operational parts of the business.

That level of business intimacy is slowly ebbing away.

“Finance leaders at large companies are now much further away from the underlying business and don’t necessarily know what the norms should be,” says Brian Shanahan, founder of Informita, a London-based working capital consultancy.

They are also failing to use all the tools at their disposal. According to Ash Noah, Vice President, External Relations, Management Accounting at the American Institute of CPAs, companies aren’t taking the time to configure their financial reporting software properly.

“The software is capable of so much more, but people haven’t taken the time to develop that expertise at a user level,” says Noah. “They’re just taught the basics. That is where the challenge is… it’s still the human element causing the errors.”

The reality that all businesses face is that mistakes will never be completely eliminated. In fact, as regulatory and compliance requirements continue to become more complex and as the demand for faster access to information from all parts of the business grows, the potential for errors is arguably only going to go up. Unfortunately for CFOs, the consequences are also getting more severe.

In the on-going fight for consistency and accuracy, technology can be both friend and enemy.

If outdated systems and ad-hoc processes are in place, taking a proactive approach to problem identification and resolution can be difficult or even impossible. However, by using technology to automate key tasks and provide a level of oversight that is no longer possible through manual means, finance departments can not only dramatically reduce the risk of errors, but also put themselves in a position to play a more strategic role within their organizations.

Karlo A. Bustos CEO & Chief Analyst Karlo Bustos is a proven strategy and finance professional. Karlo has diverse industry knowledge focusing on financial performance and market analysis.

Karlo is a respected and trusted advisor, with his financial analysis and global commentary being published in all of the top world business publications.

3

Mitigating Financial Errors While Providing Actionable Reports

|

|