Neil Robertson of Compleat Software, discusses the merits of improving cashflow through commitment accounting and explains how it can now be achieved quickly and affordably.
Surviving a recession requires the effective conservation and management of corporate cashflow, reflecting falling revenues, extended payment cycles and the increased probability and impact of bad debts. The pressure on cashflow liquidity will intensify at a time where the banks can represent more of a threat then a financial life line.
Most organisations manage cashflow through extrapolation of corporate budgets, substituting ‘actuals’ from the management accounts on a month-by-month basis and projecting cash requirements using the future budgets. This practice reflects a practical solution in a strong market, but in a weakening market where cash becomes slower, is increasingly ineffective as the budgeted numbers become inappropriate.
The monthly management accounts will usually include a significant number (and value) of accruals reflecting the ‘educated-guess/projection’ of costs incurred that have not reached the accounts department for authorisation. These still need to be posted to the accounting system by the end of the month.
This problem is exacerbated by decentralised budget management. Each department knows what their budgets are, but the methodologies for managing spending are often different in each department and handled by non-financial staff, which invariably leads to mistakes and maverick spending. The result is a cashflow forecasting methodology that is always out of date, permanently incomplete and prone to underestimating cash requirements as little as four weeks out.
To put current budget based manual methodologies into perspective, most organisations are using the same processes that existed before computers: multi-part manual purchase order sets, manual (or Excel) based recording of values and 100% manual processes for purchase invoice approvals. While this approach has been acceptable in a growth market, the requirements of most businesses have changed. Budget control and accurate cash forecasting has become critical.
Automation to deliver commitment accounting and centralised budget control
The primary benefit of commitment accounting is the ability to view and report on all purchase order commitments, recurring costs, standing orders and direct debits based on their projected payment date, providing complete visibility of future cashflow requirements from the moment a commitment is made.
The second major benefit is that it enables the centralisation and control over budget management and all corporate spend by the finance department.
Budget control can automate the validation of every purchase against the appropriate budget, in the appropriate period, at each step of the authorisation process. If a requisition goes out of budget, the authorisation workflow can automatically add a step into the process, delivering the request directly to the finance director for approval or rejection, for example. Over budget spending becomes a matter of choice.
When the budget check process is ‘real-time’ (accessing the information directly from the accounting system), then any change to the centralised budgets within the accounting system will instantly impact every single requisition that is already in the process of authorisation as well as every future requisition yet to be created.
The finance department gains the ability to instant lock down corporate spend, providing a subtle and finely tuned tool that ensures corporate cash is used in the most effective method possible.
As cashflow becomes increasingly tight, the ability to accurately forecast the business cash requirements 8 - 12 weeks in advance can mean the difference between weathering the financial storm and floundering, potentially over a relatively small amount of cash.
Implications
The introduction of commitment accounting requires the electronic creation and capture of all purchase orders as they are generated. For most organisations, this requires the adoption of new disciplines for a considerable number of staff and winning their support and co-operation is essential.
The education of staff can be very straight forward if a web-based application is selected, as almost all users will already have experience of using on-line purchasing from Amazon, eBay and others. The creation of an electronic requisition can be as simple to use as these sites by using a point and click methodology (through ordering templates and catalogues) for common items.
Accurate general ledger coding is also greatly simplified through automation of the account selection process. Company, department, expense and project selection are addressed from drop down menus, the available selection being reduced to reflect the role of the individual raising the requisition and the type of goods or services being ordered. Templates and catalogues can automate the process completely.
Once the general ledger coding is completed, budget management is totally automated. Each purchase order creates the commitment against the relevant budget (even if your accounting software does not support this feature). If goods and services receipting is used, commitments are automatically reversed to accruals. Commitments and accruals are reversed on purchase invoice posting to expense/asset transactions.
The automation of the requisition and purchase ordering process has many other commercial benefits. Companies can consolidate their purchasing from multiple suppliers of similar goods/services to improve buying prices and payment terms and ensure that the decision is enforced by removing alternative suppliers.
More importantly, the formal recording of every purchase order with values and anticipated delivery dates removes the vulnerability to changes in prices and quantities of less formal methodologies, whilst locking down available delivery addresses can protect against fraud.
Automated goods and services receipting
The majority of organisations have minimal to no formal goods and services receipting process, often reflecting that no formal or documented order was created. Implementing goods and services receipting against an authorised electronic order is both simple and fast. It is the most basic control that ensures you received what you ordered and removes the reliance on purchase invoice approval as the only checking mechanism.
Automated purchase invoice approval (with document management)
When there is an electronic record of the order, already matched against the delivery of goods and services, then purchase invoice capture, approval and posting takes moments. If the three-way match of order, delivery and purchase invoice agrees (within a defined tolerance), the purchase invoice can be automatically approved and posted.
If there are discrepancies, an image of the purchase invoice can be attached to the electronic order and delivery information and sent electronically for authorisation, leaving all the purchase invoices within the sanctuary of the finance department. Every invoice under query can be centrally managed to avoid supplier conflict, being placed on stop or cash with order. All anticipated finance transactions (commitments, accruals, credit notes, returns etc) are centrally managed and instantly updated within the reporting.
Summary
There has never been any question on whether commitment and centralised budget management is superior to budget-based accounting. The challenge has been the costs, complexity and time required to implement suitable software.
This has changed. There is now a growing number of comprehensive purchase to pay, automated order processing, or electronic procurement software solutions available that are easy to use and very quick to implement. More importantly, the return on investment calculation is quantifiable and in the majority of organisations will be achieved within a few months. Lastly, commitment accounting ensures that financial management teams obtain the tools that provide the time to avert a financial disaster.