The recent financial crisis has led to significant questions about the chief financial officer’s (CFO) control over financials, including capital adequacy, dividend-paying ability and return on capital. Furthermore, future and expected regulatory changes will pose even further challenges, as the CFO moves towards new principle-based requirements for reserves and capital. This is to come in line with the recent Basel III and Solvency II regulation. Implementation of these proposed changes will prove difficult for some, especially for those CFOs whose master data management and projection systems are not well established or as robust as they should be.
In light of this, the modern CFO needs to rethink how they assess and communicate the performance of their businesses, and develop systems and processes that can generate timely, secure and auditable information. In addition, the actuarial processes necessary to measure liabilities are likely to differ significantly from the ones now in place. Organisations will also need the right assumption-setting processes and robust experience investigations. Experience shows that implementing these processes are not simple, and will require strong data management competencies and models, as well as ample time for testing and interpreting and verifying the results.
However, before CFOs can tackle these upcoming changes in financial and regulatory reporting, they need to have a clear understanding of the capabilities of their financial and regulatory reporting (FRR) function. In order to do this, CFOs must assess the current state of the organisation in terms of the five following steps:
Stage 1: Prepare and Produce Financial Results Correctly
The initial stage of financial reporting evolution is the technical process. This is where the organisation is focused on producing the required information and financial statements correctly, according to the standards specified in existing regulations. Analysis of the results may not be as robust as the CFO might like, and may focus more on establishing compliance, rather than on understanding how to use the information to make decisions.
Familiarity with the standards is critical at the start. Specifically, the organisation must be able to appropriately apply the specific methodologies and bases to the affected business. As an example, consider what was then called SFAS 157 (pre- codification). Implementation of this regulation required an initial understanding of both what was affected (fair values) and what was required in the calculation (risk margins).
Stage 2: Controls and Governance
Gaining confidence in the organisation’s reporting results is the next step in the evolution of the financial reporting process. Strong audit controls and good governance practices are essential to this step. Sarbanes-Oxley (SOX) transformed the accounting and auditing practices at companies everywhere with new certification standards, the expanded role of the audit committee and greater responsibilities for the board. As a result, there is greater pressure on the CFO to ensure that controls and governance are performing and that risks are addressed.
Organisations in the governance phase will implement robust controls for the process of developing the reported results. This often includes moving many of the elements of the calculation to a production environment, minimising manual intervention. In addition, companies at this level will typically streamline the process for more efficient reporting. Companies in the governance phase are able to produce financial information more quickly and with greater confidence than those in the technical phase, enhancing the usefulness of the financial information.
Stage 3: Analysis
Once companies are able to quickly and efficiently produce the required financials, analysis becomes a central issue. Analysing and assessing performance is a key stage in the reporting process because it allows management to understand the profitability of a product or line of business for example
The ratios and projections are crucial to assessing past performance, creating comparables, presenting projections and setting performance benchmarks. Why are the results emerging as they are? What happened over the last reporting period? This level of analysis is the next step in adding value as a reporting function.
Stage 4: Forecasting and Budgeting
Budgeting and forecasting are crucial to planning and to the overall success of any organisation. However, budgeting for CFOs is more complicated these days, given the complex nature of some of the critical components of their balance sheet. When a company can project these elements effectively, it significantly improves the quality of its financial planning and budgeting functions.
This is an area where many companies struggle or rely on approximations. This may be due, in part, to competing priorities for computing power and staff resources. There are systems such as SAP enterprise resource planning (ERP) available to accommodate the technological demands. However, these systems are not very flexible, as they have been deployed over a period of time to serve a specific function. This is why a strong service provider partnership is needed in order for the CFO to deliver a more flexible approach to the financial reporting process.
Companies operating at this level are able to then use enterprise resource planning (ERP) systems to produce multiple forecasts for value-based activities such as scenario planning. The ability to produce realistic projections also allows for more extensive use of the actuarial control cycle. This is a significant step in developing financial information of strategic value.
Stage 5: Driving Decisions
The ultimate goal of every CFO and the finance function at all companies is to provide timely information to reach the final step in the FRR process – driving business decisions. CFOs leading highly evolved financial reporting functions are better able to work at the strategic level – working both to improve broader financial information in other areas of the organisation, such as pricing to determine improved metrics for management purposes.
The CFO who can produce timely and accurate information in a controlled manner, on both projected and historical bases, with a clear line of sight from financials to company actions, is invaluable to the organisation.
In summary, new financial and regulatory reporting requirements have placed great strains on the resources of CFOs and in some cases, the requirements have revealed shortcomings and weaknesses in data, accounting, governance, analysis, budgeting and forecasting. Greater regulatory changes lie ahead as CFOs move towards fair-value accounting, new principle-based regulations for reserves and capital, and Solvency II. Therefore, the challenge for CFOs is ensuring that the finance function can deliver under the new requirements. The CFO must be able to determine where the company’s financial reporting function is on the evolutionary scale in order to determine how to move forward.