Your actual accounting financial statements are automatically synchronized; shouldn’t your FP&A forecasted financial statements behave the same way?
In part 1 of this series we saw that whether a company’s accounting processes are manual (please don’t even think of it if you are looking to set up an accounting system for a new business!) or computerized, as is found in practically all businesses these days, the financial statements produced by the system (e.g., income statement, balance sheet, statement of cash flows) are always synchronized with one another.
This means that all accounting transactions that originate in sub-ledgers, representing specific areas of transactions, for example, inventory transactions, sales transactions, or purchase receipts, are going to post to the General Ledger (GL) in such a way that entries affecting the income statement will be posted to income statement accounts and entries that are supposed to affect the balance sheet are going to be posted to balance sheet accounts, either directly or through the income summary account. This will ensure that both the income statement and the balance sheet, plus the resulting statement of cash flows are going to be accurately produced by the system.
All this is possible due to accounting rules built into the actual accounting software. Financial statements are merely automatic compilations of values from the GL trial balance. These financial statements use different sets of values for different accounting periods, but in each period (e.g., FY2020 Period 11, FY2021 Q1, etc.), there will be a set of financial statements conveying the results from that particular period. Using multiple periods, one can also compile comparative financial statements (e.g., February 29, 2020 balance sheet vs. February 28, 2019, etc.).
The same concepts were used when there were no computers around to perform these tasks. The rules were the same, albeit more difficult to completely and accurately apply every time a transaction was recorded. There were a lot more potential and actual errors and much more troubleshooting and adjustments were necessary.
Another important aspect of using GAAP when setting up accounting software systems – the same was true for the old manual systems – other than the required compliance with the SEC, financial institutions, or voluntary compliance in privately held enterprises, is that GAAP is a set of principles and standards, that when consistently applied by similar companies within a certain industry, comparing financial statements both across different companies in the same industry and internally within each organization becomes more intuitive, accurate and meaningful.
This implies that for internal use, companies that consistently apply GAAP will be able to better analyze their performance over time. This is mainly due to the ability to run comparative multi -period and multi-year financial statements whether or not they must comply with this requirement.
There is, however, another profound implication. The same relationships that exist among the three main financial statements can be used when preparing the forecasted financial statements, or when the corporate budget is defined and approved.
Why is this so profound?
Having actual accounting synchronized financial statements is a given. You routinely close accounting periods and generate financial statements reflecting your company’s financial performance in these closed periods, as well as quarter to date, year-to-date, etc. What if you could do the same for future accounting periods? In fact, for all accounting periods defined in your budget. If you employ rolling forecasts in your budget, this will imply having synchronized financial statements of future periods for as long as your rolling forecasts continue.
As you are reading this article there are FP&A applications, some more advanced than others, that do just that. These software solutions are getting better every day. Their goal is to allow senior managements to have insight into the future financial health of their organizations. To do that, you need complete and accurate data that reflect the actual accounting data projected into future periods using the budget data and assumptions as main drivers.
Here’s how it all works:
You produce your corporate budget which is a compilation of all budget contributors’ data. In doing so you employ drivers and use KPIs unique to your business or your industry. You go through the review process, make changes, perhaps even produce more than one version of the budget for comparison and analysis.
If your FP&A software incorporates intelligent planning all budget records produce automatic journal entries into a budget GL, you will get not only an income statement, but also a balance sheet and statement of cash flows for each period of your budget. These financial statements will always be synchronized to one another, just like their actual accounting counterparts.
How is that possible?
Intelligent planning based software has all relevant GL accounts defined in all budget record categories so when the budget is executed all the required journal entries are made in the correct GL accounts, in the right accounting periods and in the right amounts, just like in actual accounting. This technology employs automated double entry accounting where the sum of all debits and credits in each entry are equal. The difference here from actual accounting is that these journal entries represent accounting transactions that are planned for the future, using budget data.
The best part is that budget users and contributors, as well as budget administrators and other finance personnel don’t ever have to make any journal entries into this ‘budget GL’. Everything here is 100% automated, assuming that all GL account definitions exist in the system, a one-time effort that can be used not only in the current budget, but in all current budget versions and ‘what-if’ scenarios and also in future years’ budgets.
The end result:
For every version of the budget and what-if scenarios there is a set of financial statements always in sync with one another. As we saw above this is due to the fact that this new technology employs double entry accounting when processing the budget, so you get complete and accurate financial statements that look like they came out of your actual accounting software.
Now that you have these future period financial statements you can easily perform analysis in your FP&A analytics module. Here you can have comparative balance sheets, comparative income statements and statements of cash flows, along with combination reports that include budget periods alongside actual periods. Modern-day FP&A solutions allow the analytics process to be performed without dependence on IT.
With good data comes good insight. If this data represents future accounting periods and if these synchronized financials are analyzed and common financial tools like ratios and other benchmarks are applied, a realistic insight into the organization’s future financial health becomes available.
Armed with these tools, finance managements can now convey these insights to their senior managements where decisions can be made ahead of time, in response to what these synchronized future period financials and analytics tell.
I think it is finally time to replace old tools and methods with contemporary, intelligent software solutions and let the future become less uncertain now.
Alan Hart, MBA, is Principal Consultant at Pacific Shine Group in Portland, Oregon, with responsibility for client business development and hands-on client project implementations. Prior to starting Pacific Shine Group, he worked in various executive accounting and finance positions with technology and growth companies. Notable is his 18 years in the hi-tech manufacturing industry where he served as Controller, Vice President of Finance and CFO of several privately as well as publicly held companies in the Hi-Tech industry, such as Hybrid Arts, Inc., Hamilton Bay Associates and Syncronys Software. In his role in management consulting, Alan has worked in diverse industries and with a variety of clients, including fortune 1000 companies such as Boeing, Delta Airlines, Intel, Wyndham Worldwide and others, as well as many mid-market organizations such as Guitar Center, Ducommun AeroStructures, Cypress Semiconductor, TriQuint Semiconductor and others.
Combining his skills and experience in engineering with deep understanding of technical accounting, he is able to assist small and medium-size manufacturing companies establish GAAP compliant accounting and reporting systems.