Audit committee to CFO: can we talk? Audit committees want much from CFOs. Characteristics topping the list include integrity, honesty, knowledge of the business and industry and guts. Most of all, they want the CFO to communicate--the good news, bad news or in between.
Directors on audit committees have always been expected to be capable, be prepared for meetings, ask good questions of the CFO, help with strategy to set risk-tolerance levels, etc. They still perform those functions. What's different now is that they, too, are discharging their responsibilities under a spotlight. The difference is not the responsibility, but rather the accountability. And, boards are looking to CFOs to fill the gaps.
As a certified public accountant, former CFO and CEO Gerald M. Czarnecki characterizes the CFO/audit committee relationship as having gone through a "sea change." Recalling when he was the CFO of a public company, he says his role "was a more dominant relationship with the auditor and a not-so-dominant one with the audit committee;" he was the primary contact with the external auditor.
Now, the audit committee has the dominant relationship with the accounting firm and the CFO has become a participant in the audit committee's activities, as opposed to the audit committee a kind of participant in the CFO's activities.
As someone who's served on boards for about 20 years (currently audit committee chair for three public company boards and chairman and CEO of Deltennium Group Inc.), Czarnecki says that previously, there was little interface between the CFO and the board. Today, "boards see the CFO as having a direct responsibility to the board," and look to the CFO to provide an added perspective on the company. He quickly adds this is not to be interpreted that the CFO is a "covert spy" on management.
Boards expect, he continues, "that the CFO recognizes that he or she is the eyes and ears of the board on financial matters, and should feel comfortable that they have a pipeline to the board." While there were some "tight" relationships in the past, he states, it is now much stronger.
Suzanne M. Hopgood characterizes the CFO/audit committee relationship as "a key relationship for the audit committee." Hopgood has served on boards for about 15 years, is president and CEO of business-consulting firm The Hopgood Group LLC and is also a member of the teaching faculty of the National Association of Corporate Directors (NACD). She currently serves as the financial expert on the audit committee boards of two public companies (Acadia Realty Trust and DHB Industries Inc.) and one private company (Newport Harbor Corp.), for which she expects to soon be on the audit committee.
The audit committee, she says, "depends on the CFO to provide timely, accurate and complete information and to discuss any issues--whether large or small in their eyes--that the committee needs to be aware of to be certain that we can put everything in a context, that we understand the risk and understand what accounting treatments are being used."
If there are options, she adds, "we need to understand the decisions that have been made along the way, whether there's adequate staffing and how the numbers were put together." Additionally, she says, if the CFO heard anything during a board meeting that was not consistent with his or her understanding of what was occurring at the company, or if a board member had a misunderstanding of what was occurring, "it is certainly our expectation that he or she would speak up."
Prior to Sarbanes-Oxley, notes Hopgood, a new person on a board would generally be placed on the audit committee. At that time, she says, "the only thing you did on the audit committee was beat up on the auditor's fees."
Not so for today's audit committees, which engage in "meaningful and long discussions about process, staffing and competency on staffing, the complexity of the information we're dealing with and involving outside consultants." Notable, she says, is that the number one reason for restatements is understaffing; thus, she's particularly interested in knowing that the CFO is comfortable with staffing. The statistic, she says, "opened my eyes," adding, however, that "this is something we can fix."
Marilyn Seymann is a director on the boards of Maximus Inc. and State Farm Bank and serves on the audit committees of both. She says she receives from State Farm's CFO a monthly financial highlight that includes not just financials but also narratives that show trends. "We don't have to wait until a quarterly board meeting to be surprised at a positive or negative trend," she says.
Seymann, an associate dean of the Sandra Day O'Connor College of Law at Arizona State University, believes it's important for the board to establish a rapport with the CFO. She expects finance chiefs to deliver the financials and accompanying data in a format that the board wants and understands, since not everyone on the board is a finance expert.
Seymann, who also teaches courses for NACD, says that those who are financially trained are comfortable getting a P & L statement and balance sheet, while others prefer to see some narrative or annotated numbers. In her classes, she instructs CFOs to "ask the directors how they prefer to see their financials." You'd be astounded, she exclaims, "to find that more than 50 percent prefer to see something other than numbers--be it narratives, graphs, charts, trends and more."
Indeed, explains Seymann, besides more pressure on CFOs, there is also heightened awareness of what directors are expected to know. People are asked to sit on boards for a variety of reasons, and not necessarily for their financial acumen. In many cases, she notes, a member may be a brilliant strategist, a brand marketer or the former governor of Florida or mayor of Cincinnati and have great political connections.
"Not everybody is going to be everything, so you do have to have your own protection [and] enough comfort that you're understanding the financials; otherwise you're making decisions based on less-than-perfect information, and liability for directors is quite high."
And, since adults learn in many different styles, Seymann says, it's reasonable to request that CFOs deliver information in a format that's easy to understand and is delivered in time for boards to absorb.
To any CFOs in her classes who sarcastically ask if this means they have to do cartoons, Seymann replies: "If you have to do cartoons so that a director is educated well enough to make a good decision based on good information, then start drawing!"
The Importance of Being CFO
Hopgood believes good CFOs are the hardest positions to fill. "You're looking for someone with great financial savvy--who knows when to hedge, when to refinance debt, how to man- age the financial pieces of the business--while, at the same time, someone who gets the accounting done properly. And both of those are very, very complex pieces." If one person doesn't know both sides of the job--the financial and the regulatory--many companies split the role, but getting the right skills is key.
Hopgood, whose company handles restructurings, among other business issues, says that in assessing troubled companies, one of the consistent pieces is either a CFO who's not at the level he or she should have been or someone who has been corrupt. "The CFO position is so key in protecting the company and protecting the board," she argues.
Seymann believes the CFO is so important to the board that "it's a real working partnership." Additionally, "I count heavily on the CFO, as I count on legal council. The legal counsel is a very strategic partner, and the legal counsels that aren't very good are the ones that can tell you the law but never tell you the law as it applies to your business."
She adds that CFOs, too, have to understand the business model for the business they're in and be conversant in their specific industry--along with its regulatory requirements, deadlines, guidelines and more.
As for what boards want from the finance chief, Czarnecki notes that they expect clear and unambiguous information about the metrics that drive the enterprise. As such, they see routine financial reports, income statements, balance sheets, cash flows, etc. But most boards, he says, "are looking to the CFO to drill down past just the formal financial statements and get into the information that helps to explain what the drivers of the business are." Among these: Why is revenue growing at the rate that it's growing? What's happening to gross profit margin? What are the key characteristics of SG & A in the enterprise, and what drives the increases or decreases?
Czarnecki says he wants to see good, solid insight from the CFO as to why the numbers are what they are, and not just what they are. Frankly, he argues, "it's the same kind of information that I, as a CEO, wanted the CFO to provide me." Fundamentally, over time, he believes boards have gotten to ask the same questions as the CEO. The audit committee also looks at things other than the business drivers, such as internal controls.
"The most important thing that a CFO can do is either know the answer to the 'why' question, or when the question is asked about a specific thing, to be responsive in getting the answer."
He relates that when he was a CFO reporting to the board, he'd occasionally get an unanticipated tough question. His response: "I don't know the answer, but I'll get it for you." And he'd "work my heart out to get it before the board meeting was over from someone who could run after the data; or make sure that I had that information and could get back to the person who asked.
"Being responsive to the board when a question is asked is an important part of what a CFO has to do," says Czarnecki.
Board's CFO 'Wish List'
When asked what qualities they wish CFOs would possess, topping the list were communication and integrity (besides financial brilliance, naturally).
Seymann says in addition to great communication skills, she wants "complete and total honesty in the sense of bringing things to the attention of the board that we need to know, and a person with confidence so that questions from the board are not perceived as 'an indictment.'"
For example, she says, if the CFO presented financials and you asked, "Could you tell me what the percentage of probability that you're going to make those numbers?" She expects the CFO would say "Oh, 85 to 90 percent, or I wouldn't be presenting them," versus: "How should I know, these numbers are from marketing?"
While she recognizes the CFO isn't the one responsible for making the numbers--and the numbers may represent a huge over-commitment by marketing people--she does expect that if the CFO puts those numbers in the budget, that they would be vetted. "On the other hand, if he or she thinks there's only a 50 or 40 percent probability of making those numbers, I'd expect to hear: 'I think we're at risk for making these numbers; these are very aggressive.'"
Another quality Seymann stresses is guts. "It takes guts to speak up when there's pushback about doing so," which can come from a CEO who wants to be the one to decide when to disclose bad news.
Integrity is high on Czarnecki's wish list. "I want to know I can trust the CFO implicitly and believe that he or she would never do anything inappropriate." He also wants the CFO to be fearless about telling the truth: "I don't want it sugar-coated." And he wants a CFO who is as candid and forthcoming with good news as the bad news.
Also, he wants the finance chief to understand the dynamics of the business and expects the CFO and the people around him or her to be technically competent. This goes back, he says, to his "why" questions. He wants the CFO to not only have a good answer to the "why" questions but know that he/she is focused on those and is asking those questions of line management in relation to peers and potential competitors.
Finally, Czarnecki doesn't want good performance to be accidental--"and that I wake up one day and find out that the numbers really didn't reflect what the underlying business was doing."
Hopgood wants a CFO with a high level of honesty and integrity and a strong value system. "The CFO is the board's first line of defense. If something is wrong, the CFO has to tell you." Even, she says, if he or she doesn't know what's wrong, but is just not comfortable with something--whether it's risk, someone being aggressive with the numbers or an earnings issue, and the CFO is being asked not to tell the board or audit committee the whole story--"they have got to be in your face very quickly."
Next is a high level of competence--to be extraordinarily good at understanding the numbers. Also, the CFO has to be a good manager.
"I've seen a strong look-back ability," says Hopgood, but it's also important for boards and senior management to be able to forecast. "You want to know if in nine months or a year and a half there's any indication that there's going to be a liquidity problem, where is the money that could be affected and 62 different things that none of us thought about."
Indeed, in light of the liquidity issues affecting the global markets in August, Hopgood says one of the things that boards all ought to be asking CFOs is: "Is there any chance that we're going to have a liquidity issue in the next 6, 12 or 18 months because of things going on today?"
It's no wonder, she comments, that "CFOs are under as much or more scrutiny today as they've ever been. The expectation of CFOs is enormous--the job skills, experience, judgment. The turnover rate, [with] CFOs in jobs for a low number of years, on average, is pretty indicative of the pressure of the job and the expectations.
"Look at the characteristics I just described," Hopgood adds. "It's no surprise that it's a hard job to fill."
Kenneth Daly has some unique perspectives on CFOs and audit committees, based on his extensive experience working with both. In May, he began his post as president and CEO of the National Association of Corporate Directors (NACD). Prior to that, he was Executive Director of KPMG's Audit Committee Institute (ACI), having been a KPMG partner since 1978.
Daly has seen enormous changes in the CFO role, as well as in the CFO/audit committee relationship. "There has been a substantial increase in the demands and expectations of audit committees and a substantial increase in what's expected of the CFO." This, he adds, is not only in terms of "raw data, but relates to data quality."
The tension caused by this new CFO/audit committee relationship--particularly following Sarbanes-Oxley implementation--seems to be "sorting itself out." However, says Daly, "it's a journey, as CFOs are struggling to understand the audit committee expectations and audit committees are struggling how to best utilize the CFO."
Acknowledging reports of record-high CFO turnover, he says, "CFOs give as one of the important reasons for exiting a job the demands being placed on them by audit committees and the lack of clarity about audit committee expectations."
He stresses the need for education--for both CFOs and audit committees, as both their roles evolve--and lists a few areas where he believes CFOs can help audit committees:
* More discussion time -- Allow 50 percent to 70 percent of the agenda for discussion (for asking questions and receiving answers; not just listening and watching "movies").
* Industry comparative data -- Go beyond inventory turns and the like and discuss accounting estimates and judgments. How does the application of our accounting principles align with our industry?
* Disclosure issues -- Not mandated; committees want the CFO to inform them how the disclosure process is working.
* General agenda-setting -- Help with prioritizing the critical matters and minimizing the relatively less important.
* Assist in managing auditors -- Both the external and internal auditors.
* Strategy -- Board members generally do not fully understand the company strategy and consequently don't necessarily understand the risks that may flow from that strategy.
* Risks -- Assist in helping them understand the critical risks, and who is responsible for risk management oversight.
Daly says that "communication requirements have gone up dramatically for CFOs--and more is needed than ever before." Yet, he adds, "few of them are particularly well-trained or well-suited for that endeavor."
Not many, he notes, said to themselves in college: "I'm really good at communications. I think I'll become an accountant!"
RELATED ARTICLE: TAKE AWAYS
** Audit committee relationships with CFOs have changed dramatically since Sarbanes-Oxley. From what was previously little contact, CFOs are now expected to be the eyes and ears of the board on financial matters.
** CFOs are required to deliver financial information on time and in a format that can be understood. More than 50 percent of directors prefer to see something other than numbers--be it narratives, graphs, charts, trends, etc.
** One reason for recent high CFO turnover rates is the demands being placed on them by audit committees and a lack of clarity about audit committee expectations.
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|Title Annotation:||BOARDS OF DIRECTORS|
|Author:||Heffes, Ellen M.|
|Date:||Oct 1, 2007|
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