Risk management and management accountants
The idea of accountants taking risks tends to go against the stereotype image that accountants get – you know, grey suit, drives a Volvo and so on. Businesses take risks everyday, based on information available and sometimes on experience or gut instinct. Management accountants provide a lot of the information needed by managers to make decisions on a daily basis. One wonders though what happened to assessing risk in banks in recent times. I am reading a book called Downfall by Joseph Stiglitz at the moment and he sure has a lot to say about the lack of risk assessment by US (and European) banks on recent years. In one passage he talks about how banks assumed the risk of other banks failing, or of a property-crash were seen as minimal. But look what happened.
I read a piece back in January in CIMA’s Insight on risk management and management accountants. The key message from this article was that management accountants need to get the message across about risk. They are after all providers of information for decision making, and are training in risk management. As noted in the piece, defining exactly what risk is is not that simple. It seems risk managers may not have been overly involved in decision-making at high levels in recent times. The author suggests that risk managers and managements accountants work closely together to get the message across about risk. I couldn’t agree more. Management accountants may have shook off the dull, boring stereotype and are now often part of the management team and/or board. Thus, as the article suggests, risk managers might piggy-back on the organisational knowledge of management accountants and get active in the areas where risky decisions are being discussed or taken – i.e. at board level.
The key points on Key Performance Indicators
Robin Tidd wrote a very concise article in Accountancy Plus recently (see the December 2010 issue here) on the subject of key performance indicators (KPI) in a business. According to Tidd, while around 90% of Fortune 500 companies utilise tools like the Balanced Scorecard to report on KPI, 70% are not happy with their reports. Tidd, rightly points out that this is not a problem with the tools used – such as a Balanced Scorecard – but more likely the application of the tools. He makes a few key points which I summarise below.
1. Don’t mix up KPI with key reporting indicators.
The best example of this is profit, which is a result or outcome.
Of course these results are essential, but tell nothing about what
caused the result. For example, have profits increased due to
improved productivity or customer satisfaction.
2. Use maps of your organisations processes to help find the best KPI.
3. Be careful to look at all processes and not just departmental ones. This avoids choosing KPI which may be sub-optimal.
4. Compare KPI on a regular basis, keeping the reporting interval short. This allows for faster corrective action.
5. Use the KPI on the front-line on a regular and routine basis. This fosters continuous improvement in all processes.
You can read the full article here http://is.gd/jLEn2
Preventive maintenance – a good investment?
This article on The Economist website brought me back to my days working as a management accountant in manufacturing firms. Maintaining manufacturing and process equipment was always a delicate balance. Spares and maintenance staff pay was quite a substantial cost in one plant I worked in over the years. This plant, like others, tried its best to engage in preventive maintenance programs. This usually implied using a mixture of following guidelines from equipment manufacturers and the experience of the maintenance staff. But, as I am sure you can imagine, preventative maintenance comes at a cost too. The arguments would always be “should we wait until it breaks, or fix it before it breaks”. Of course, letting a piece of equipment go unmaintained can create serious problems. A business needs to avoid its main manufacturing process being down – losses of revenue per day (or even per hour) rack up very quickly. So from an accounting and profit view, a balance needs to be achieved between the right level of preventive maintenance and the cost of same.
Of course modern technology can help. When I left my last manufacturing role back in 2004, process equipment could be remotely diagnosed and repaired by engineers. I always remember being amazed in or around 2001 when a production manager told me how the main machine at our plant had PLC’s (programmable logic circuits) with an IP address – the same as any PC or internet device. This meant the engineers from the equipment manufacturer could simply connect over the internet. At the time I was thinking, wouldn’t it be great if fault information could be sent out instead, or even better, that fault signs might be noted in advance.
So, reading the above mentioned piece from The Economist brought me back to those great days when I as an accountant was constantly amazed by how advanced machinery had become. But now it seems a “virtual engineer” may be on hand to predict if electrical equipment is showing early signs of failure (read the piece for more detail). No detail is given on the cost of such devices, but it would seem to be a great cost-saving idea. It could mean that preventive maintenance costs are incurred less frequently as equipment may be perfectly fine beyond it’s normal maintenance period
Brand valuation standard sets challenge to finance
CIMA’s Insight e-zine from November 2010 (here) reports on a recent ISO standard which give guidelines on attributing a monetary value to brands. Under international accounting standards (IFRS3 in particular) brands are normally only valued when acquired as part of a new business (i.e. only when bought). According the CIMA piece, the new ISO standard suggests three well-known methods for valuing brands:
- Income approach: the objective of the income approach is to calculate the after-tax, present value of future cash flows attributable to the brand. These cash flows are the difference between the cash flows generated by the business with and without the brand. The standard outlines six key ways of doing this: the price premium, volume premium, income split, multi period excess earnings, incremental cash flow and royalty relief methods.
- Market approach: this methodology compares the brand with comparable transactions, looking at acquisition ratios that can be adjusted to consider the similarity of brand strength, goods and services or economic and legal situation.
- Cost approach: the cost approach calculates the amount invested in creating the brand and the cost of recreating it.
The ‘forgotten’ part of performance management
I recently read an article in The Economist online http://bit.ly/aiSE5K about assessing the performance of fund managers. I found the article quite interesting, as we all know how people in the financial sector have been (and still are) rewarded based on their performance. And, what bank or fund has really performed in recent times?
The article mentions an idea called the ‘inertia benchmark’ – this the performance which would have been achieved if a fund manager did absolutely nothing. This measure could then be compared with the actual performance of the fund to assess if the actions of a fund manager actually yielded better results. This idea made me think do business owners and managers ‘forget’ the meaning of improved performance? As accountants we can create plans, monitor actions and report on performance against plans. And we know too how important it is to use the right performance indicators. In larger companies and many SMEs, reward systems are often linked performance ( banks and funds are a good example), and performance is often measured in terms of profit – again something accountants are good at measuring. So understanding, or more precisely, defining, the meaning of performance can have a big effect on rewards and the information needed to assess it. I wonder how many managers ask themselves what would have happened if the course of action taken was actually to do nothing. Yes, this would be tricky and identifying an inertia benchmark would be considerably more difficult than with a fund. But it might be good to consider such ideas when performance and reward systems are closely linked.
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