Fast Close for a Public Company (#77)
/In this podcast episode, we look at ways in which the time required for a public company to produce financial statements can be reduced. Key points made are noted below.
Problems with a Public Company Closing
On top of all the regular closing steps that a company follows to close its books, a public company has one extra step – which is to file either a quarterly 10Q or annual 10K report with the Securities and Exchange Commission. If you’ve listened to the earlier fast close episodes, you’ll realize that everything else can be completed in just one day.
This extra step is an entirely different story. Most public companies feel lucky if they can file their 10Q reports in just one month, and the 10K’s take even longer. So let’s see what we can do to cut back a bit on the amount of time needed.
The first problem is that you have to write either a quarterly 10Q or an annual 10K report as soon as you’ve finished the financial statements. This is a hard bottleneck, since several other steps can’t start until this is done. So, you need to assign a specialist to assembling the report. This person should be totally cleared from all other activities while writing the report. In my company, I have a part timer who’s the assistant controller for external reporting. That’s her title, and that’s all she does. She spends her time before the close just assembling the information that she’ll need, and once the internal financials are done, she has absolute priority over all other projects going on in the department.
Writing the report will take multiple days, even though there’s a lot of boilerplate that can be copied forward. After you’re through with that step, there are the auditors.
The second problem is that the quarterly results have to be reviewed by an outside audit firm, and the annual results have to go through a full audit. So right there, you need the cooperation of an outside entity, and which very likely doesn’t have excess staff available to help with a fast close. Instead, they just schedule you into an open time slot, and that’s what you get.
However, there are some ways to reduce the amount of required auditor time. First, try to retain the most experienced audit staff for as long as you can. If the audit firm keeps rotating in new hires, then the review or audit will take longer. Second, line up all of the in-house staff you can to assist the auditors with absolutely anything they need. By making life simple for the auditors, you get them out the door quicker. Third, increase the strength of your internal controls. If auditors find problems, they’ll spend more time on-site, so the trick is to have super-strong controls that reduce the chance that there’ll be any issues for them to find.
Fourth, and actually the most important, make double-sure that everything the auditors requested in advance is completed before they arrive. These are called the provided by client items, or PBC for short. Otherwise, they waste time sitting around, waiting for you to provide them with the requested items. In fact, though this sounds like reverse logic, it can make sense to delay the auditor start date just to ensure that you have time to put together the entire PBC list. Fifth, reference supporting documentation in the 10Q or 10K, so the auditors can easily trace back to where you derived your numbers. We do this by blocking out reference notes in yellow right in the SEC reports, and then remove the notes just before we file the reports.
The third main problem is the legal review. The company’s legal counsel has to review the report to make sure that it includes all mandated disclosures, and doesn’t include any incorrect or unsupportable statements. Unfortunately, and just like the auditors, the attorneys don’t work for the accounting department, so the controller has no influence over when they do the work. However, this is not as bad as it seems, because the attorneys can review the report at the same time that the auditors do, since each party is reviewing the report for something different. In essence, they can do the work in parallel, so the attorneys aren’t really a bottleneck at all.
But you’re not done yet. There are still three more steps before you can file the report. Fourth in line is officer certification of the financials. Under Section 906 of the Sarbanes-Oxley Act, the CEO and CFO both have to certify that the financial statements fairly present the company’s financial position. If they don’t, then the CEO and CFO can be fined up to $5 million and spend 20 years in jail. Given the penalties, it’s fair to assume that they’ll both want to spend some serious time reviewing the report.
But, like the attorneys, this doesn’t have to be a bottleneck. They may agree to review the report at the same time as the auditors and the attorneys, and just be notified of any subsequent changes.
And then we come to problem number five, which can be a significant problem. This is the audit committee’s approval of the financials that are contained within the report. This is usually a very simple conference call that takes about 15 minutes. The problem is that the meeting date is usually scheduled well in advance – in my company, the audit committee schedules all four quarterly report discussions at the beginning of the year. So – if you try to schedule the audit committee meeting too soon and you’re not ready, then the audit committee is pissed off. If you schedule it too late, then you’ve wasted some days when the report could’ve already been filed.
There’s no easy solution to this one. I prefer to schedule somewhat delayed audit committee meetings for a full year, then make damned sure I can meet their schedule, and then tighten the meeting dates in the following year – and so on.
And finally, we have edgaring. This is the conversion of your 10Q or 10K report into a format that’s acceptable for filing in the SEC’s edgar system, which is short for electronic data gathering, analysis, and retrieval system. The usual approach is to outsource edgarizing to a specialist. These people are inundated with reports coming in from all of their clients at the same time, so it can be more than a one-day turnaround. The auditors conduct a final review of the edgarized version, and then you can tell the edgarizer to file the report for you.
A couple of pointers regarding edgarizers. First, consider using a small local firm that might appreciate your business more than a large national firm. I use a shop where I’m the largest customer, so they turn around my reports in just a few hours. Also, this is where being ready to file early really pays off, because you’ve beaten the rush – if you file early, you’re ahead of everyone else, so you’re not stuck at the bottom of the edgarizer’s work queue.
So – I dropped a lot of tips regarding how to file public reports quicker, but the basic problem is that you absolutely cannot get the reports filed in anything like the single day that can be done for internal financials.
In a public firm, you have to run through all kinds of external entities over whom you have very little control – there’s auditors, attorneys, the audit committee, and the edgarizer – so you have to measure success in terms of shaving a few days off here and there.