VALUE-ADDED ACCOUNTING

Getting Value from your Accounting System

Abstract
Is your accounting system adding value to your organization? Find out how to transform your accounting system from simple reports to a powerful decision-making tool.

YourBackOffice.com
bmolloy@ybo-mi.com

Table of Contents
Introduction.................................................................................................................................................. 1 Weaknesses of traditional accounting systems .......................................................................................... 1 How a value-added accounting system can help ........................................................................................ 2 Important Considerations ............................................................................................................................ 3 Cost-Benefit .............................................................................................................................................. 4 Expertise ................................................................................................................................................... 4 Time .......................................................................................................................................................... 4 Conclusion .................................................................................................................................................... 5

Introduction
Has this happened to you? You are going over your financial statements and something doesnt seem quite right. Based on experience, your gross profit on sales should be much higher than what is being reported. You try to understand the cause of the eroding margins. You ask your senior managers and none of them can point to a smoking gun. You try to dig deeper into the issue, but the information that you and your team need is either difficult to get or does not exist at all. How do you get the information you need to determine the problem? How did you not have that information in the first place? Likely, the problem lies with your traditional accounting system.

Weaknesses of traditional accounting systems

The traditional accounting system was designed for one purpose: to prepare financial reports for external users (banks, investors, owners). As a result, a lot of emphasis was placed on setting the system up to capture the data needed to generate financial reports in accordance with Generally Accepted Accounting Principles (GAAP). These reports are useful for their intended audience and producing these reports will continue to be a major emphasis of accounting systems in the future. But these systems were not designed to answer the critical questions regarding your companys profitability. Some examples of these questions are: 1. 2. 3. 4. Which customers, products, or jobs are the most profitable? Which customers or products do we need to exit? Where are we going to see profitable growth? Has our marketing campaign been successful in generating new business, or have we simply given a discount to customers we already had?

These are important questions that your team needs to be able to answer in order to increase your companys profitability. But too often, it requires a significant amount of time to gather (and in many cases, recreate) the data necessary in order to even begin answering these questions. And the time spent gathering this data is time not spent servicing your customers. Consider as one example the traditional payroll system. Each day, employees record the time they are at work. At the end of the week, the employees supervisor reviews the time data to make sure that the hours reported are accurate, that no punches in and out were missed, and that all employees are accounted for. Once approved, this information is used by the payroll system to generate accurate paychecks. All of these activities are designed to satisfy the needs of external parties. As service providers to you, your employees need to be paid accurately, and your financial statements need to accurately report your payroll expense to external stakeholders. But this process does not answer the critical question of which jobs, products, or customers are profitable. Your supervisor may have a daily budget of hours
Copyright 2014 by YourBackOffice.com. All rights reserved. This material may be freely copied and distributed subject to inclusion of this copyright notice and our Web URL http://www.ybo-mi.com

that he compares his report to, but this is often as far as it goes. This information is important, but it is too broad. It does not get down to the level necessary to truly understand what jobs, products, or customers are impacting your margins. In order to answer that question after the fact, your supervisor will need to go back to the employees old time records, try to remember what they were working on, setup a spreadsheet to allocate employees time to various jobs, and then use that data to determine what is happening to gross margins. All of this takes time, time which your supervisor likely does not have.

Employee Paycheck Payroll Process

Employee Timesheet

External Financial Statements

Figure 1 -- "Traditional" Payroll Process

How a value-added accounting system can help

In order to become what we are calling the value-added accounting system, the system must broaden its scope. Notice that we did not say change its scope. Your accounting system will always need to prepare financial statements (Balance Sheet, Income Statement, Statement of Cash Flows) in accordance with GAAP for external users. The mark of the value-added accounting system is its recognition that it must also satisfy the needs of internal managers. It asks those managers what information they need (and how often they need it) in order to answer the critical questions they face. It then sets out to accurately and efficiently capture and report that data in easy-to-use formats, allowing mangers to spend more time answering questions than they spend gathering data. Consider the example from above. The supervisor in this example likely spent countless hours reviewing old timesheets to allocate time to jobs or customers. Worse still, because this data is being recreated after the fact, it is doubtful that the data is highly accurate. As a result, your management team is left to make general assumptions about what is happening to margins, even after all of that time has been spent gathering the required data. In the value-added accounting system, the need for this data is anticipated. As a result, the system is setup to capture and report this data. When employees time is being entered daily, the system is also asking for which jobs or on which customers the employee is working. Any time spent not working on specific jobs or customers is captured in a general category. When the supervisor is reviewing employees time, the detail of what job the employee worked on is
Copyright 2014 by YourBackOffice.com. All rights reserved. This material may be freely copied and distributed subject to inclusion of this copyright notice and our Web URL http://www.ybo-mi.com

included. In addition, the report summarizes total time worked by job or customer as well as the total time spent on general labor. He can review the time by job for reasonableness. If the time spent on general labor is excessive, he can get with the sales team to go out and get more work because he has more capacity than he thought. Alternatively, perhaps the time on a particular job was much higher than normal. The supervisor looks at the detail and sees that a new employee was in training and spent much longer on that job than usual. Your supervisor now knows what is driving reduced margins, and more importantly, he can take action. He can spend additional time training the employee to avoid future problems. Finally, the supervisor may conclude that the time spent on each job or customer is reasonable. Perhaps the problem is that your costing system has not been updated to reflect reality, and as a result your sales team is being given faulty information to use in the quoting process. Your team now knows in real-time that they need to update the costing system in order to provide the sales team with better data. No matter the result, by anticipating the needs of your companys internal users, the value-added accounting system has empowered your team to take corrective action in real time. Another key attribute of the value-added accounting system is that it has a feedback loop which allows it to mature and become more robust. Because the users of the traditional accounting system are external, often the only feedback to the system is the annual audit. But in a value-added accounting system, managers are interacting with the system daily and are constantly providing feedback on errors they have found, how the data can be improved, and how reporting can be streamlined. This results in a system that is in continuous improvement mode and as a consequence often leads to better reporting for both internal and external users. That is, the value-added accounting system can lead to better reporting for external users (the focus of the traditional model) as well.

Employee Paycheck Employee Timesheet by Job Payroll Process

External Financial Statements

Hours by Job or Customer

Are Hours Reasonable?

Can we improve? (Kaizen Process)

Corrective Action

Figure 2 -- "Value-Added" Payroll Process

Important Considerations
Just about every company in America, large and small, is awakening to the power of the value-added accounting system. You have undoubtedly heard of the push for big data analytics. Fortune 500 companies are adding teams of financial analysts to develop these systems, only to find that they need better information from their accounting system to be successful. As a result, these teams are setting
Copyright 2014 by YourBackOffice.com. All rights reserved. This material may be freely copied and distributed subject to inclusion of this copyright notice and our Web URL http://www.ybo-mi.com

out to convert their traditional accounting systems into value-added systems. For large companies, they have the time and resources necessary to devote to this effort. But for small businesses, does converting to a value-added accounting system make sense? In most cases, the answer is yes. Clearly, some companies are small enough that the management team can know what is happening on a daily basis without the need for modifying their accounting system. However, for most small businesses, their current system simply does not provide the information they need in a ready-to-use format to achieve growth in their bottom line. So what are the considerations a small business needs to keep in mind when transitioning to a value-added accounting system? Cost-Benefit Done correctly, transitioning to a value-added accounting system does not need to break the bank. Modifying your traditional accounting system does come with a cost, however. There is the need to design and test the reports and make the required modifications to the systems inputs. You may need to invest in new printed forms, or a consultant to redesign an input screen. The keys to making this process successful are beginning with the end in mind and discipline. Remember, the goal of the value-added system is to provide your team with the information they need in a ready-to-use format so that they can answer the critical questions they face every day. In order to provide that data, the system needs to know what questions are important. Usually, that means which questions will either confirm your strategic direction or cause you to make changes. By understanding what these questions are, the data required can be defined and in most cases the current system can be quickly tweaked to provide that data. In the previous example, it was simply a matter of adding job data to the employees time entries. The second requirement is discipline. Once users start to get helpful information from the accounting system they always want more. You must be disciplined to make sure that providing that data will provide answers to the critical questions you have identified. Otherwise, you will begin to experience scope creep and the costs of providing the additional information will outweigh the benefits of that information. Expertise Your accountant likely has a solid understanding of how to capture and report financial data to end-users. But how involved is he or she in your daily operations? Does your accountant know what critical questions managers face? Can your managers explain or do they even know what data is required in order to answer these questions? Transitioning to a value-added accounting system requires that your entire team understand the questions that need to be answered and the data required to answer them. It will take a cross-functional team to define these requirements, and often it is managers with experience in other companies or other industries who can bring the most insight to these discussions. Time Servicing your customers takes time, and so does the effort to adopt a value-added accounting system. Time spent in this effort is less time spent servicing customers. So the project needs to
Copyright 2014 by YourBackOffice.com. All rights reserved. This material may be freely copied and distributed subject to inclusion of this copyright notice and our Web URL http://www.ybo-mi.com

be defined broadly enough that your company realizes the benefits of the effort but narrowly enough that you avoid scope creep. It will take time to manage the project, define the outcome, and then dive deep into the details to implement the changes. It may be necessary to bring in outside resources to assist you in this effort. For this reason, it is critical that the scope of the project is sharply and clearly defined. When transitioning to a value-added accounting system, all of the above considerations must be kept in mind. While the challenges are significant, as long as the benefit of providing the additional data outweighs the cost of providing it, then the effort is critical in order to achieve a competitive advantage and increase your bottom line.

Conclusion
In todays competitive environment, businesses are looking for any way to gain a competitive advantage in order to increase profits and achievable profitable growth. For many companies today, and many more in the near future, implementing a value-added accounting system is an important part of gaining that competitive advantage.

Copyright 2014 by YourBackOffice.com. All rights reserved. This material may be freely copied and distributed subject to inclusion of this copyright notice and our Web URL http://www.ybo-mi.com

About the Author

Brian Molloy has over twenty years of experience in the accounting industry, in both public and private accounting. While in public accounting, he managed the audits of several small and large companies in the automotive, manufacturing, retail, distribution, and not-for-profit industries. He has served as divisional controller in a Fortune 500 manufacturing firm and Director of Financial Planning and Analysis for a multinational, publicly traded manufacturing company. He is currently President of YourBackOffice.com, specializing in assisting small and mid-market companies with their accounting, tax, and consulting needs. He can be reached by email at: bmolloy@ybo-mi.com or through his firms website at www.ybo-mi.com.