Figuring out Undocumented Processes (#174)
/In this podcast episode, we discuss how to gain an understanding of the controls and processes of a business when there are no written ones in place. Key points made are noted below.
How to Manage the Documentation Process
This is important for a controller, since controls and processes are precisely what you’re responsible for. So, how do we go about doing this?
There is an easy solution. If the company has been audited in the past, it’s possible that the outside auditors have already done an analysis of processes and controls, and they can walk you through them. And provide a commentary about which controls don’t seem to work too well. So that’s your best way to go about it. But what if there’s no audit?
Well. In the typical organization, there could be a couple of dozen processes that the accounting department is involved with, so it could take a long time to figure out how they all work. So your first step is to prioritize. Which process needs the most attention?
To be blunt, it’s the process that’s most likely to get you in trouble if it doesn’t work right. And most of the time, that’s going to be customer billings, since not getting invoices out on time, or doing them wrong, is going to impact cash flow. So we’ll use the customer billings process as an example.
Example of Process Documentation
The first step is to interview the most senior person who handles billings. Use the interview to document how the process is supposed to work. Then go back over your preliminary procedure with the person, and see if you got it right. Then watch them do an actual billing, and see if it matches what you have in the procedure.
This gives you a rough understanding of how the process works. And – the documentation should include controls. So – take a look at the controls that you’ve been able to identify and see if there’s anything missing. If you think there might be, go back to the person you interviewed, and see if the missing control actually exists, but you just didn’t write it down the first time.
At this point, you probably have a reasonably accurate procedure, and a decent grasp of the controls. But that doesn’t give you the in-depth level of knowledge that’s expected of a controller. In addition, there needs to be a system in place for spotting screw ups. For example, an invoice isn’t priced correctly, or no sales tax was charged, or the customer won’t pay because an item was billed that was never delivered.
You can obtain this extra knowledge by keeping an eye on adjustments that flow through the billing system, like credit memos, or invoices that are written off and replaced. When you investigate these items, they’re good indicators of where the process is breaking down. Then make a note of the issue, and revise the process to fix the issue.
And that’s how you gain an understanding of controls and processes.
Areas to Investigate
So, what are the main areas to investigate? It’s going to vary by the type of business, so for example the processes for an insurance company will be quite different from the ones used by a casino or a restaurant. But at a minimum, you’ll need to focus attention on the big three processes, which are customer billings, accounts payable, and payroll. Once you have an understanding of those three, the next biggest process and controls mess is probably in the recordation of inventory. And after that, look at the two areas that involve cash, which are cash receipts and wire transfers.
That usually covers the main processes that can get you in trouble.
Now let’s take this from a different direction. The person who suggested the topic asked if you could understand controls and processes by looking at the chart of accounts and financial statements. My answer for the chart of accounts is no – the types of accounts used don’t tell a whole lot about processes. Accounts are just the buckets in which you store information.
The financial statements, on the other hand, can offer some clues. If the recognition of revenue and expenses in the financial statements seems to jump around a lot from month to month, that probably means the processes for recognizing revenue and accruing expenses are not being followed – if there’re any processes for closing the books at all.
And that brings me to the one other procedure that can get the controller in trouble, which is closing the books. If the financial statements aren’t reliable, then the underlying processes need to be documented and cleaned up. And that can take a long time. I talked about how to close the books back in episodes 16 through 25, and few more times since then. You might want to go back and listen to those episodes.
The Priority of Documentation
What I’ve outlined here really isn’t that difficult. The problem is that a new controller has a lot to do, and may not get around to these familiarization activities for a while. That can be a big mistake, since a basic knowledge of accounting processes is considered fundamental for a controller. If a few months go by, and you still don’t know how the systems operate, senior management is definitely going to think that you’re incompetent. And that means figuring out controls and processes should be completed early on, no matter how hard it might be to jam in the work.