EVENT TO KNOWLEDGE.
Event to Knowledge (E2K) measures how long it takes an organization to record and report an event to an information consumer. E2K is an integral part of viewing the finance function of an organization as a value chain unto itself
How fast can your finance department close the books and get financial information to your organization's decision-makers? More important, how long does it take your managers to review the financial reports and then act on the information provided? Try comparing your finance department to the following fictional organization, Acme-Close Inc.:
While Acme-Close Inc. is fictional, the estimated times are not. According to the Hackett Group, five days to close a financial period and four days to produce financial reports are the norm. Distributing hard-copy reports is the time to print, sort, package and deliver the reports to a multi-site organization. The reader-wait time is the time that it takes line managers or executives to "get around to" reviewing the financial reports. And finally, there is the actual review time -- the one day a manager spends reviewing the financial statements. However, given that the information is now 43 days old, how relevant is it to today's priorities and issues?
E2K and your finance department's value chain
Of course, not all of the information the manager is reviewing is 43 days old -- some of the events occurred as recently as 13 days prior. But, on average, the events occurred 28 days ago. Forty-three, 28 and 13 days represent the various Event-to-Knowledge (E2K) timeframes for Acme-Close Inc. Forty-three days is the maximum E2K, while 28 and 13 are the average and minimum E2Ks.
E2K is a deceptively simple measure that has important ramifications for finance departments. It goes beyond many traditional finance department metrics by focusing on the point at which finance adds value to the organization. Think of E2K as measuring the length of finance's value chain. For many managers, the only value they see the finance department adding to the organization is the month-end reports they receive. By reducing E2K time, finance can deliver value to its internal managers sooner and give the managers more time to act upon the knowledge gained from that value.
While many finance departments have shaved days from their maximum E2K through more efficient month-end closes and online reporting, leading-edge companies like Cisco Systems have shaved weeks off their maximum E2K. Through the adoption of continuous improvement techniques, new technology and rethinking traditional finance processes, your organization can potentially reduce your maximum E2K time from 43 days to less than 43 hours.
The information consumer. The first step in rethinking the finance department value chain is identifying the end consumer of the department's product. As every financial professional knows, there are many and varied audiences for financial information.
In general, there are two internal information consumers within an organization -- those individuals either in a management or transactional position. Managers are typically responsible for variances to a budget and/or overall financial results. Transactional audiences are interested in the detailed activity within the organization, such as clerical staff reconciling accounts. In either case, both of these audiences require timely, accurate and complete financial and non-financial information from the finance department.
Rethinking your finance department's vaLue chain
Month-end close. In the mid-1990s, the just-in-time (JIT) management philosophy moved from the manufacturing floor to the finance department. Thus, just-in-time accounting (JITA) and one-day reporting were born. JITA's goal was to reduce the total close cycle from days or weeks down to a single business day. This dramatic reduction in time was accomplished by compromising detailed, precise and highly accurate information for more summarized and materially accurate financial information. Some short cuts for JITA included the following:
JITA has been given a boost in the past five years by the improved integration and sophistication of Enterprise Resource Planning (ERP) systems. One of the causes of a long accounting cycle was the wait for sub-ledgers to close, extracting and balancing the information, and then posting it to the general ledger. Integrated financial systems reduce the non-value-added reconciliation activities between sub-ledgers and the general ledger.
Financial reports. JITA also recommended the use of "flash reports." These reports are a quick approximation of results to indicate if performance was in line with expectations, with a more detailed confirmation of the result to follow in due course. In introducing flash reports to an organization, education is key. Managers must fully understand that the margin of error for these reports is higher than in the traditional financial reports that would follow.
A strong selling point for introducing flash reports is the value of parallel processing. If a manager identifies a significant accounting error in his or her reports, the error can often be fixed before the final traditional month-end reports are produced. This, in turn, reduces the need for adjustments in the following month and generally improves the quality of financial information.
Distribution of financial reports. Up until the mid-1990s, paper was the preferred medium for communicating organizational results. Paper was cheap, permanent and relatively easy to distribute with an appropriate infrastructure.
Paper is becoming harder to justify as the preferred medium for internal financial audiences. In one health care organization, for example, six clerks would spend the better part of a day in a small room packaging the financial reports for about 500 information consumers. These reports would be sent through the internal mail and would then arrive on the manager's desk in another day or two. Many of these financial reports would then be stacked in the corners of offices, still wrapped in their original inter-office envelopes. It was a tragic waste of human effort and energy.
In our fictional organization, Acme-Close Inc., digital distribution of financial information will eliminate the entire two-day report distribution activity, thus reducing the maximum E2K timeframe by the same amount. By using a corporate intranet, electronic versions of paper reports can be distributed to end-users within minutes of their creation.
Wait and review time of financial reports. An e-mail announcing the availability of the electronic reports reduces the wait time for managers. Unfortunately, simply converting paper reports into an electronic version misses the true value of the digital environment. Consider this perspective: until a knowledgeable user has looked at and acted upon the information available in a financial report, the entire effort and process of producing that report has been non-value-added to the organization.
This leads to the question of why not simply produce only the portions of a financial report that will be used? If an information consumer only wants to see a single transaction, why produce an entire accounts payable transaction detail? The answer, of course, is that by using the paper medium, the finance department had no way of knowing which portions of their financial reports various users within the organization would use. Consequently, organizations would either send out massive, detailed reports or would send out summary information and then ask the information consumer to contact the department if they required further details.
Digital distribution of reports allows finance departments to produce information on demand. One method of doing this is by allowing each information consumer to create and update a capstone report. The capstone report provides specific summary information individually tailored to the consumer. Thus, if the capstone report reveals all activities are within their normal parameters, a manager's financial review is potentially complete within minutes. Variances or oddities are investigated by progressively drilling down into problem areas. Capstone reports can either be active of passive. An active report tells the consumer when a reportable event has occurred while a passive report relies on the consumer to discover this fact for him or herself.
With the application of technology, wait time can be reduced and the information consumer can use the information more efficiently. Both of these improvements will further reduce the organization's maximum E2K cycle.
Informating instead of reporting. The adoption of digital report distribution allows organizations to migrate from a reporting to an "informating" mentality. Informating is the process of empowering users of financial information to make critical decisions without the need for hierarchical intervention. While informating in itself has limited impact on an organization's E2K times, it can have a dramatic impact on an organization's effectiveness and efficiency.
Calendar month. No matter how efficient an organization's reporting or informating processes are, the most dramatic reduction of E2K time can be achieved by matching an organization's fiscal period to its natural business cycles. Returning to the health care organization mentioned earlier, one of the largest costs for this organization was labour. All employees were paid on a bi-weekly pay cycle even though the financial period remained the calendar month. Therefore, the organization needed to calculate, reconcile and the reverse payroll accruals every month. A 14-day fiscal period would have made more sense for this organization. That is, instead of closing its books once a month or 12 times a year, the organization should have closed its books 26 times a year, at the end of each pay run.
Changing the accounting calendar is not a change to be made lightly. There is the added cost of closing the books more frequently than 12 times a year, the loss of industry standardization, or the influence of regulatory reporting on the organization. With the first difficulty, the cost of closing more frequently can be mitigated by adopting JITA practices and by moving toward a more integrated and efficient Enterprise Resource Planning (ERP) system. The loss of industry standardization or the need to adhere to an externally imposed accounting calendar can be mitigated by either adopting accruals for external audiences or by having multiple closes.
For example, if your organization has quarterly reporting requirements, then it is likely already performing a number of accruals and adjustments to meet these requirements. Rather than imposing these external reporting obligations on internal managers, adopt a non-standard calendar that allows these managers to focus on operational issues. Consequently, the burden for making required external adjustments then moves to the finance department. Part of this burden may include having a soft close for a quarterly reporting obligation.
Of course, one way to avoid accruals is to close your books every 24 hours. Cisco Systems has recently achieved this breakthrough and is able to provide its managers with financial results from the prior day by 2 p.m. The 24-hour or "virtual" close is accomplished by having business transactions posted continuously.
Knowledge -- making better information consumers
The work described above will deliver better financial results sooner and more efficiently to an organization's s internal information consumer. This work will not deliver knowledge to the end consumer, however. This is the other challenge for financial departments -- to ensure that its information consumers understand and know how to act upon the financial results presented to them. Central to this challenge is the need for consumer education and information tool development.
Education is particularly important in organizations where the information consumers may not have been exposed to finance concepts in their post-secondary education. For example, in another health care organization, a basic "Finance for Dummies" course dramatically improved the confidence level of the managers taking part. Courses like this can decrease an organization's total E2K cycle.
Time -- the ultimate non-renewable resource
Getting information to the end consumer quicker, and having the consumer understand this information faster, conserves one of the organization's most valuable resources -- time. This time can then be reallocated to activities that are more productive. For the finance department, these activities could include the more value-added activities of coaching, advising and assisting the organization to become more competitive and effective.
Although empirical evidence does not yet exist to prove this, it is reasonable to expect that for each marginal decline in the E2K timeframe, there is a corresponding increase in the efficiency and effectiveness of the organization. In time, experience and research will determine what the marginal change is and at what point the organization receives diminishing returns for its E2K efforts.
This article has exclusively focused on internal information consumers because they have the greatest stake and ability to act on financial information. If the fictional managers of Acme-Close Inc., or your organization, are able to make better-informed decisions faster and see the results of these changes faster, then the organization as a whole has improved.
This, in turn, benefits the external stakeholders, such as investors, creditors or governments. Thus, while E2K, JITA, or the virtual close will not change the format or perhaps even the timing of externally reported information, E2K will improve the quality of the information and performance of the underlying organization.
Reducing the E2K timeframe has two parts -- improved transaction processes and improved organizational knowledge. Virtual closes and one-day reporting are important advances in making transaction processes more efficient. However, finance adds the greatest value when it assists information consumers and decision-makers in converting financial information into competitive knowledge and action. The "K" of the E2K measure is the prime value-added activity of the finance function.
Frank Potter is an Oracle Financials consultant with MONTAGE eIntegration, Inc., a Canadian-based company which provides integrated information solutions throughout the world. Event to Knowledge is part of a larger organizational change management and organizational efficiency framework.
This article is a joint publication effort by CMA Management magazine and Strategic Finance magazine, which is published by the American Institute of Management Accountants (IMA).
Event to Knowledge cycle of Acme-Close Inc. Fiscal Month Activity Total Days 30-day calendar month 30 Month-end close 5 Produce financial reports 4 Distribute hard-copy reports 2 Reader-wait time 1 Review time and action is taken on 1 a variance or anomaly Total 43 Days Short Cut Examples Increasing the materiality of Raise the capitalization threshold adjustments. or threshold for accruals. Pre-calculate month-end Calculate depreciation in the last adjustments. week of the month rather than after the month-end close. Increase the frequency of If the financial system allows for sub-ledger postings to the general it, post more frequently and use ledger. the finance staff to review and correct unusual entries or variances -- before the month-end close. Question the value of all financial Carefully review the value of business processes. allocations, distributions and transfer pricing schemes. (Obviously, this last point has larger organizational impacts beyond the finance department.
Putting it ALL Together
Six steps to reducing your E2K timeframe
Measuring the marginal benefit of a 43-hour versus a 43-day E2K timeframe may soon be moot. However, Cisco CEO John Chambers predicts that the virtual close will be a competitive imperative by 2010. To stay competitive, how can Acme-Close Inc., our fictional organization, make such a dramatic improvement in its financial processes? The following six steps provide a guide for all organizations wanting to reduce their maximum E2K timeframe.
1. Benchmark current practices
Measure your current maximum and average Event-to-Knowledge time periods. Pay particular attention to the reader-wait time and review time. Remember that internal financial information only becomes value-added when a knowledgeable information consumer reviews the information and then acts on it. By acting on it, the organization's financial results are transformed from information to knowledge; thus, the E2K cycle is complete. Deciding to do nothing is a valid action on the part of the information consumer.
2. Move toward just-in-time accounting
What processes and steps in your accounting cycle can be eliminated, realigned or redefined without impacting the quality of the financial information? The use of quality circles, customer involvement (internal information consumers) and just-in-time techniques (such as celebrating every success and statistical methods) are critical to successfully implementing just-in-time accounting.
3. Invest in systems
Just-in-time accounting and the virtual close are dependent upon integrated and efficient information systems. This step is the most costly, time-consuming and important in reducing E2K cycle times.
4. Adopt informating in addition to conventional reporting
Internal financial reporting is largely a non-value-added activity. Moving to an information model focuses on the most value-added portions of this finance activity. Empowering the consumers of the information to act moves financial information from a retrospective correction model to a prospective prevention method of doing business.
5. Adjust your accounting cycle to match your natural business cycle
This change requires careful consideration and planning to minimize the negative impact on your organization; it will also yield the greatest reduction on E2K cycle time. While a 24-hour virtual close is the current gold standard for an accounting cycle, adopting a biweekly or weekly close can yield enormous benefits for an organization as well.
6. Hone the E2K measurements and results
Initial E2K measurements may focus on the transactional aspects of the accounting cycle. Subsequent measures should focus on how efficiently and effectively financial information is transformed into knowledge.
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|Title Annotation:||finance department efficiency standard|
|Date:||Jul 1, 2001|
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