show clients issues and opportunities in the current process.
by domenick j. esposito
8 steps to great
presented below is an example of an effective tool for distinguishing your firm from the rest – the ebitda/working capital improvements memorandum. this tool can be used when your client is owned by a large private equity group or other investment vehicle.
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the ebitda/working capital improvements memorandum is designed as a unique byproduct of your attest services. at the conclusion of your attest services, you share preliminary thoughts and observations on how to improve ebitda/working capital with senior management of the portfolio company as well as with an outside investor such as a private equity group.
if there is a desire for you to assist with the implementation of your suggestions, you, of course, would be happy to do so – understanding that there are certain limitations, particularly for public companies.
in the example below, acme technology corp. asked its cpa firm to take a hard look at the company’s performance planning and analysis capabilities, and to identify improvements that could translate into ebitda and working capital enhancements.
example: the ebitda/working capital improvements memorandum
acme technology corporation
performance planning and analysis
1. background
acme desires to improve the effectiveness and efficiency of its performance planning and management activities, including budgeting (revenue, expense, cash flow and balance sheet); sales and resource planning; and reporting and variance analysis of performance against plans.
as a result of our firm’s valued relationship with acme, members of our team spent several days to help management gain an outside, objective perspective on the company’s current process, and to make some top-level recommendations for improvement in both ebitda and working capital.
our people met with the chief financial officer and finance, operations and sales support personnel over two days, to review the current planning as well as reporting and variance analysis processes, and to identify improvement opportunities.
the purpose of this memorandum is to capture – at a high level – the existing process and issues as reviewed during those two days, and to provide a suggested road map for ebitda, working capital and process improvements.
performance planning and management – high level – as is
current process
- create and update five-year plan
- create annual plan
- monitor and update sales forecasts
- monitor and update resource plans
- produce monthly reporting: financial and management
- update financial forecasts
- quarterly board meetings and financial review
five-year plan – acme has a five-year plan, originally developed in 2014 and updated in march 2015, that defines the company’s long-term goals, including profitability, cash flow and balance sheet composition. as budgets are prepared annually, they are compared against the five-year plan to refresh the long-term outlook and to identify potential gaps, both near- and long-term. identified gaps are then reviewed by the management team to develop specific strategies to close those gaps.
annual plan – acme finance, sales, marketing and operations leadership develop a budget annually. for the 2016 budget, the process is targeted to culminate with a board presentation and approval of the budget in november 2015.
critical inputs to the annual plan include:
- revenue from backlog – backlog information is maintained in multiple excel worksheets as well as in the project management system.
- revenue from pipeline – sales pipeline information is used as a starting point, but is reviewed, edited, filtered and changed.
- revenue recognition rules and assumptions are applied against both the backlog and pipeline to translate sales into revenues.
- employee labor and contractor expense projections are modeled in excel worksheets and reviewed and modified by leads. a project management system is used as a reference, but headcount planning is conducted separately in excel worksheets.
- strategic initiatives and goals are communicated from top management and worked into the department plans and budgets.
- multiple planning meetings and plan iterations are developed over several months to determine targeted goals and to close gaps identified between the annual and long-term plans.
sales forecast monitoring and updates – sales forecasts are monitored and updated regularly. weekly, the sales pipeline is reviewed and a pipeline analysis and forecast is distributed. a revenue flash report is also distributed weekly. and on a biweekly basis, the sales department reviews the pipeline with operations.
project and resource planning – the sales pipeline and backlog change frequently, so operations regularly reviews the most current forecasts and adjusts resource plans accordingly. biweekly pipeline review meetings are held with sales. the pipeline provides expected start dates and durations. to forecast the level of effort, operations applies judgment and rules of thumb against the forecast, especially for items in the pipeline identified as “stretch.” once an opportunity gets to the requirements assessment stage, the company has a clearer sense of what’s “real” in the forecast – both the revenue and the resourcing needs. the backlog and forecast are then input and tracked to identify actual versus projected resource requirements.
monthly reporting and variance analysis – monthly results, key metrics and variances from plans are reported and analyzed, including:
- monthly financial reporting package, which includes current month, year-to-date, year-over-year comparatives, monthly trends and budget versus actual reporting
- balanced scorecard reporting
- project profitability is calculated in an excel “profitability workbook” using data from the project management system and links to other data (resource cost information, etc.)
quarterly board meeting and financial review – the acme senior management team prepares a business and financial summary and reviews this with the board. the board reporting includes the monthly package and supplemental reporting including quarterly portfolio and project profitability analysis.
2. current process – issues and opportunities
five-year plan
- updating and refreshing the five-year plan requires a large effort. the five-year plan includes a revenue model by customer (licenses revenue, services revenue and maintenance revenue off those new licenses). the underlying data and assumptions that drive the long-range outlook reside in other systems and need to be gathered, reviewed and input into the five-year outlook.
- aligning the annual plan and five-year plan for comparative and gap analysis purposes requires additional effort.
annual budget
- the annual budget process takes nearly five months to complete, and involves multiple iterations, increasing the risk that the plan is outdated by the time it is completed.
- planning and budgeting is a once-a-year process. acme creates and memorializes an annual budget, but acme’s business is dynamic and does not stop when the annual budget period is over.
- “once and done.” once finalized, the budget is not regularly updated throughout the year to reflect changes in conditions.
- planning and budgeting are done primarily in ms excel. while excel can be a valuable tool, it is non-collaborative and has serious limitations and risks as a corporate financial tool. these include potential errors in formula and model creation, a lack of data integrity, wide variation in productivity among users, and the difficulty of maintaining and updating multiple scenarios.
- time spent on the mechanics of budget creation reduces the time available for analysis and scenario planning.
- while data from the pipeline (clear and stretch) is used as a starting point, it must be edited, filtered and changed for both financial budgeting and for ongoing resource planning purposes
- data from the pipeline and the operating system are used as a reference and starting point in the budget, but headcount planning is also developed. as a result, gaps may exist between the plan as communicated in the budget and what is actually being planned and actioned by operations.
- comparing resource capacity versus plan requirements is difficult and largely done manually in ms excel. ideally, management would like to see capacity versus requirements by portfolio, and have it available on a monthly basis to update and report against actual resource levels and activity.
- pipeline and backlog constantly change, so operations is constantly reviewing and resourcing against the new revenue and project forecasts. however, this is not easily captured to be reflected in an updated financial forecast.
- the financial accounting system has budget capability but is limited to values only. it cannot calculate budget using underlying drivers or assumptions, and acme’s planning process involves a number of key drivers and assumptions. this also limits the system’s ability to report budget versus actual at the driver or assumption level.
- the current reporting system can drive top-level financial reporting, but there is nothing in the general ledger at the next level down. there is no ability to drill down from top-level financial reporting to the next levels to understand and analyze trends and variances.
- to report at the line-of-business level requires a dump of financial information to ms excel so that it can be matched up against the project and portfolio management data:
- project profitability is maintained in an ms excel file, which requires so much effort to update that it is only updated quarterly. as a result, early warning signs may not be identified when actions and changes are needed.
- the project profitability worksheet uses an “average rate by role” approach; methodology to account for labor utilization (e.g., when salaried people work 50-hour weeks) is needed to improve the project reporting and highlight/identify the impact of utilization on labor rates and project or portfolio profitability.
- while source information originates from software systems, financial and operational reporting are done largely through spreadsheets. there is additional manual effort required to run reports and extract information to bring into ms excel for publishing, as well as the risk of error or omission.
- comparing budget versus actual in the financial reports at the portfolio level is not meaningful, as the actuals do not capture the movement of resources between portfolios. resource movement happens routinely and is significant or material, and needs to be captured and recorded to get actual labor costs by portfolio or project.
3. desired process
- move from an annual forecast that’s fixed to a continuously updated forecast.
- easier annual budgeting; the annual budget should be an extension of the rolling forecasting process.
- leverage and capture the ongoing sales and resource planning activity that is already being performed in sales and operations at acme, and incorporate that into a rolling forecast.
- generate updated profit and cash flow projections in near real-time to reflect changing business conditions, including key sales opportunities won, lost or reaching key milestones in the sales pipeline.
- generate timely and accurate re-forecasts and what-if scenarios.
- identify trends and root causes of issues while there is time to take action on these early warning signs; develop and track initiatives to correct trends and issues.
- drive better business decisions through improved reporting and analysis.
- replace the current method of analysis with a business intelligence tool to automatically bring together information from disparate data sources, enhance integrity of data and calculations, and provide greater insight and data analysis capability.
- improve alignment of budgeting and planning efforts with the regular, ongoing planning processes in sales and operations.
- improve rigor organizationally (including sales and operations, across all accounts) to better forecast demand.
- utilize an advanced planning, budgeting and reporting application to:
- align long-range plan with operating and financial plans.
- plan and manage performance more effectively and efficiently; drive out mechanical effort – simplify and automate.
4. comparing current with desired processes
5. suggested ebitda and working capital improvement action plan
- utilize a process analysis session to validate and expand on these findings, recommendations and proposed actions in a collaborative fashion with all of the key process participants and stakeholders:
- achieve consensus on current process, issues and improvement opportunities.
- gain agreement on the benefits of rolling forecast approach that better leverages data and closes gaps between the assumptions and forecasts in the financial budgets and plans.
- define the key requirements for a budgeting/rolling forecast application as well as the desired reporting and integration.
- evaluate, select and implement a budgeting/rolling forecast application that enables both the rolling forecasts and dimensional reporting, and also streamlines the monthly and quarterly reporting and variance analysis processes:
- identify the desired dimensionality, and design reporting and data capture to enable automated reporting by these dimensions.
- implement a business intelligence tool (1) to enable continuous analysis of key performance results and drivers, and (2) to generate financial and management reporting “at a glance,” on demand and in an actionable management analysis format.
- use the business intelligence tool to automatically bring together information from disparate data sources, and quickly identify trends and variances needing investigation and further analysis.
- evaluate and define the business rules around deal progression in the sales pipeline and how and when resources are planned, allocated and committed against pipeline opportunities.
- monitor sales forecast accuracy, especially as it relates to the flow of deals to stages where resource activities occur, and monitor forecast accuracy as a key performance indicator as part of a continuous forecast improvement effort (e.g., accuracy of deals that reach the “commit” stage).
- define an approach and process to allocate labor expense (for resources who work outside of their assigned home department), to align and enable meaningful actual-versus-budget reporting of the project level.
key takeaways
- owners want to increase valuations and working capital. you can demonstrate that your firm can help by delivering, as a byproduct of your attest services, a memorandum identifying improvements.
- communicate value not only to senior management but also to investors.
- they will be blown away by your firm’s distinctiveness.