Partial Clearing

Budgeting software isn't the key to corporate finance reform, but it can help CFOs manage expectations in a sinking economy.
Tim ReasonDecember 1, 2002

If the reach of the Sarbanes-Oxley Act of 2002 can be measured by marketing spin, then Congress has indeed instituted sweeping corporate reform. After the legislation passed, vendors of all kinds of business software, including budgeting and planning tools, were quick to tout their applications as cure-alls for the new compliance headaches it created.

Of course, Sarbanes-Oxley never mentions software and has little, if anything, to do with budgeting and planning. The act doesn’t even include specific rules for market guidance — the one area of disclosure typically based on output from B&P software. And while it may be true that financial software in general can help strengthen controls within business units, such claims ignore the fact that the recent scandals were caused by the misdeeds of executives, not workers in the trenches. “If Enron had the most sophisticated enterprise performance management tools, do you think it would have made different decisions?” asks Lawrence Serven of research and management consulting firm The Buttonwood Group. “Of course not.”

But overeager public relations aside, the message from software vendors isn’t totally off-base. Although the new legislation doesn’t directly address guidance, investor skepticism gives companies plenty of reason to shore up the consistency and accuracy of their forecasts.

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Perhaps more important, the vagaries of today’s economy have made the ability to quickly adjust forecasts essential. Indeed, in a survey conducted jointly by CFO Research and Cap Gemini Ernst & Young just after the WorldCom scandal broke, 81 percent of CFOs said that accuracy of revenue and earnings forecasts was their highest priority, and 63 percent complained of inadequate, poorly integrated budgeting and forecasting systems.

The Big Package

The desire for integration provides additional justification for discussing B&P software and Sarbanes-Oxley in the same breath, since the software is often part of broader packages of financial software that can help with reporting and disclosure compliance.

The new law requires management to publicly assess “the effectiveness of the internal control structure and procedures of the issuer for financial reporting” and submit that assessment to auditors — a process that certainly could include evaluations of the controls built into the reporting software. Moreover, CFOs must now disclose material changes to a company’s financial condition “on a rapid and current basis,” produce quarterly and annual reports faster, and, of course, certify the accuracy of the results. According to Aberdeen Group Inc. analyst Alan Yong (in “Baring the Financials: More than Current Financial Systems Can Bear?” InSight, Aberdeen Group, 2002), these and other rules “will necessitate significant investment in financial software.” Yong argues, for example, that determining whether a change is material will require predictive forecasting — assigning probabilities of occurrence to each possible scenario. “In contrast,” he notes, “forecasting techniques currently used in budgeting and planning exercises look at only the most probable scenario.” Implicit in Yong’s assertion that budgeting functionality may need to be broader is the idea that it must be integrated with other financial systems.

“There should no longer be any walls between actuals and the budgeting process,” agrees Rich de Moll, Cap Gemini Ernst & Young vice president of finance and employee transformation, who conducted the survey. “CFOs need to look at transaction systems as initial feeders, and the general ledger and account code structure as input points. All that needs to be consistently, seamlessly integrated into the budgeting process.” De Moll is agnostic when it comes to buying a single suite of software versus combining various “best-of-breed” products, noting, “there is probably no one vendor right now that provides all that any one company needs.” But, increasingly, B&P software must be evaluated in the broader context of a customer’s other financial software, as opposed to being judged on its merits as a stand-alone product category.

Although not a public company, Childrens Hospital Los Angeles (CHLA) illustrates the trend. It bought a new budgeting and planning system as part of a larger, enterprisewide rollout of PeopleSoft applications. “Out of all the systems we are replacing, our current budgeting and cost accounting system is the strongest and most stable,” says Tricia Cascione, executive director of IT development and contract manager. “It wasn’t that it was broken, it was that the enterprisewide system is going to replace it.”

Cascione, a CPA and former finance director and controller at CHLA, oversees all nonclinical applications and implementations at the hospital. “They pretty much wanted a CFO-type over IT,” she says. That’s because Cascione will oversee CHLA’s three-year capital budget to replace more than 25 financial applications — ranging from grant budgeting to payroll to supply chain — with the PeopleSoft suite.

Although the need to support a better budgeting process didn’t drive the change, the new system will be a big improvement, says Cascione. Currently, hard-copy budgets are sent out to managers, who mark them up by hand and return them — a process that is repeated several times before all of the information is entered into Excel spreadsheets and uploaded onto the old budgeting system. Ultimately, says Cascione, “we hope to go to paperless budgeting through the [PeopleSoft] portal technology.”

Cascione also expects that the new system will make it easier to run various budget scenarios. “For example,” she says, “if Blue Cross says they want to negotiate new rates, we could input them and see what the impact is throughout the organization.”

Indeed, the ability to reforecast and run alternative scenarios remains of far more interest to CFOs than any improvement to compliance. “CFOs see this economic volatility staying around a while, so they need adaptability,” says de Moll.

Updating the Forecast

Brian Reilly, CFO of building-materials distributor Allied Building Products Corp., uses a Cognos system installed in June to speed up the company’s routine evaluations of its approximately 120 distribution branches. “We take a pretty hard look a couple of times a year to see if we should get rid of underperformers,” he says. The system lets Reilly model the effects of eliminating a branch location and transferring assets and inventory to other locations.

Likewise, Huntsman Corp. relies on Applix iTM1 budgeting and forecasting software to meet the constant demands of auditors, investors, and lenders for various snapshots of the future. “We are always generating five-year forecasts for different scenarios,” says Jim Bell, Huntsman’s director of corporate finance. “We have to answer every question they can imagine.” Many of the scenarios deal with different pricing assumptions about the chemical company’s raw materials, such as ethylene and crude oil, a front-page issue today. “If we do indeed go to war [with Iraq], it would necessitate immediate reforecasting,” says Bell. “We’d see movements in the market right away.”

There are also more mundane reasons for reforecasting. In addition to five-year forecasts, Huntsman uses rolling monthly forecasts to recalibrate results for the balance of the year. “The way the economy has been lately, the most recent three months often aren’t what you thought they’d be four months ago,” says Bell.

Of course, says Buttonwood’s Serven, companies must be careful not to get carried away by modeling capabilities. “Companies that go overboard in modeling completely lose any sense of responsibility for making the numbers,” he warns. “You can use forecasting tools as a reality check, but they shouldn’t let people off the hook for delivering the revenue figures they promised. That’s the difference between crystal-ball forecasting and planning management.”

At Allied, for example, branch managers are compensated for staying a certain percentage over a threshold rate of return. With purchasing of materials handled by a central office whenever possible, that gives managers incentive to keep a tight grip on costs. “Anything they can do to drive out costs is very effective,” says Reilly. “If they save a dollar, it’s a dollar straight down.”

What the Future Holds

According to CFOs surveyed by CFO Research/Cap Gemini Ernst & Young, the finance department’s ability to predict future performance is poised for dramatic improvement. While only 14 percent of CFOs report having dynamic budgeting and forecasting based on operational drivers today, 52 percent expect to have such capabilities within three years. To get there, of course, they’ll need the support of senior management — and, once again, the Sarbanes-Oxley Act plays an indirect role.

“Audit committee members [now] are going to want to understand the financial system architecture,” predicts de Moll, and, of course, CEOs must now certify the financial results that come out of the company’s financial systems. “If the CFO puts together a business case for integrated business processes that include budgeting and planning,” says de Moll, “I think Sarbanes-Oxley should move senior management to support it.” In other words, even as vendors use new legislation to sell CFOs on the importance of financial systems, CFOs themselves may be selling CEOs on the very same thing.

Tim Reason is a staff writer at CFO.