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Thursday, October 27, 2005

IT's Role in Financial Process Improvements

From the first databases to ERP deployments, information technology has led the way in business process reengineering. Despite process improvements, corporate America and government enterprises still face errors, fraud, and data quality issues within their financial systems.

Now the challenge is to stay competitive and continually improve those processes, such as accounts payable, accounts receivables, purchase-cards, and financial reporting. IT can again play a role in process improvement.

Those responsible for these business processes face increasing pressure from government regulations, such as Sarbanes-Oxley and BASEL II, to eliminate errors and strengthen internal controls. However, fast-paced growth and corporate acquisitions only increase the risk of financial errors by creating complex IT environments with multiple ERP systems running throughout most companies.

A 2004 study from the Hackett Group reported that the average $1 billion company has 2.7 ERP systems. Most CIOs and IT managers personally deal with this headache on a daily basis. All the while, business process owners face competitive pressures to decrease their operating costs and improve efficiency or be outsourced to India.

Just like ERP deployments, IT can to lead process-improving changes by applying the proven methods for quality improvement to their financial applications. Business process owners can look IT solutions to drive out errors in their financial systems through continuous monitoring and real-time transaction inspection.

Manual Efforts

Today, business process owners rely on sample-based audits and manual review of their custom-built ERP reports to identify invoicing errors, uncollected receivables, payment errors, invalid journal entries to the general ledger, or unauthorized p-card purchases.

Most of these efforts are consumed on the backend of the process - looking for a duplicate payment or bad invoice before they hit the mail. For example, a $6 billion Midwest manufacturer devoted two full-time employees to double check payments before they went out the door. Two other employees spent most of their days correcting the identified errors by tracking down the cause of the problem and reversing the purchase orders, vouchers, and payments.

While this manufacturer placed a large emphasis on quality and catching all the errors in its financial system, the quality assurance team could only spend their time inspecting and following up on the payments that were greater than $5,000. Economically, it didn't make sense to hire two more people to check data quality within these smaller payments and another two employees to correct the mistakes. However, errors within these smaller payments built over a year to misstate the company's accounts payables by almost $400,000.

Open-Loop Controls

Spurred on by the demands of Sarbanes-Oxley, some companies have tried solutions that simulate ERP configurations to eliminate segregation of duties violations and root out the cause of many of these errors. These highly technical solutions offer "open-loop" controls that attempt to project the potential errors or acts of fraud that could occur in the financial system. However, these solutions forever cement daily involvement from IT personnel in the business process, which creates a resource problem for IT and a headache for the owner of the business process.

While useful in configuring an ERP system, these solutions require time-consuming manual reviews that increase operating costs without effectively addressing the entire problem. By tightening the embedded controls of the ERP system, these restrictions introduce barriers to productivity, which then frustrates production-line employees by restricting them from getting their jobs done efficiently.

With this mindset, IT managers risk running smack into the “productivity paradox” where investments in information systems drag corporate productivity instead of lifting it as projected. In short, tighter controls reach a point of diminishing returns because the human element can never be removed from the process. The human part of the process creates the opportunity for errors, risk, and control violations to affect the quality of your financial operations.

Further, configuration management tools typically work for only a single system and cannot correlate users, access controls, and transactions across multiple systems. IT managers must duplicate their efforts across all systems.

For these reasons, IT managers should look for closed-loop control systems that monitor quality throughout each step of financial processes.

Closed-Loop Controls

IT managers generally understand “closed-loop” controls in the context of information security. A firewall can be configured so that it does not allow Internet traffic into the corporate network, but that’s not realistic. Communication must flow into and out of the corporate network.

While configuration of the firewall remains the first step of IT security, IT managers know that they must also deploy intrusion detection or other forms of network monitoring to identify threats inside the corporate network.

In the same way, financial systems must be monitored for risk. The best efforts at prevention cannot eliminate the human element that naturally introduces errors and risk and errors into financial processes.

Financial systems demand controls that identify and prevent mistakes and violations that occur in each step of the financial processes. While controllers could throw a roomful of internal auditors to provide this level of quality assurance, IT managers should recognize the potential for technology to automate this benefit.

To effectively present this agenda for budget approval, IT managers should first understand the concepts of quality and process improvement – and how technology can drive these programs in financial processes.

Total Quality Management & the Financial Manufacturing Plant

To compete with Japanese manufacturers, American manufacturers adopted the idea of total quality management in the 1980s. In the 1990s, Six Sigma grew as another quality management movement. IT managers can apply these concepts to improving financial processes within their ERP systems.

The costs and benefits of quality within financial operations – or lack thereof – is best understood if you think of the financial processes, such as procure-to-pay, order-to-cash, and financial reporting, as “Information Manufacturing.” (Just to be clear, we’re not talking about manufacturing fictitious earnings reports.) Within this information manufacturing, these processes transform input data into more refined information.

The key to remember is that quality isn’t about having the most elaborate financial systems – it’s about meeting expectations. To this point, quality isn’t necessarily a Cadillac. A Chevrolet can have quality as long as it delivers to the expectations of the customer. Phil Crosby’s most compelling argument is that quality doesn’t have to be a cost; it can be free of you think about all the costs of an error. And every time you remove that error, you save money.

So what are the costs of processing an error within financial processes? If an invoice error produces an erroneous shipment, the correction cycle may include:

Receiving a customer call complaining about the bad shipment
Investigating the error
Reversing the invoice
Handling returned materials
Accruing for rebates & returns
Accounting for change in revenue recognition

Less explicit costs arise when the sales manager gets involved to manage the customer relationship, so the sales manager absorbs an opportunity cost by not devoting his time to call on new business.

For most Fortune 1000 companies, enterprise resource planning (ERP) systems serve as the manufacturing facility. These systems can be configured to deliver quality, but they also involve a significant human element. While ERP systems provide the conveyer belts that move information through the various steps along the process, people play a major role with regard to data entry and approvals.

The analogy in manufacturing is that you inspect for quality along the way. For example, Intel doesn’t wait until the end of the production line to look for defects within its microchips. They look at each step along the process. Intel would much rather find a flaw in a silicon wafer before they’ve burned in all the circuitry. It’s a lot cheaper to throw away that faulty wafer before investing time and production cycles into a defective final product.

IT managers should apply that same mentality to the financial processes inside their ERP systems. Look for errors and defects throughout the process to minimize correction costs and the downstream impact.

Conclusion

CIOs and IT managers can play a major role in improving financial business processes by evaluating technology solutions that automate the manual testing for quality assurance. Oversight Systems provides a continuous monitoring solution with real-time transaction inspection to drive quality through all steps of financial processes.

posted by Brian Moran @ 2:56 PM   3 comments

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