“No travel between now and the end of the fiscal year. Delay deliveries of all equipment and supplies until next fiscal year. Exceptions must be approved by the CFO.”
What are they thinking! You have a major review at a vendor scheduled for next week! If you postpone that, it will set your project back at least a month!! And your major supplier on the critical path is scheduled to ship in two weeks!! This will cause havoc with the schedule!!! It will create extra costs for delays and expedites!!! THOSE IDIOTS!!!!
Stop, take a deep breath. Don’t take this personally. (Unless you backed into the CFO’s car in the parking lot last week – then it might be personal.) In all likelihood the business is doing some “financial engineering” as it prepares to close out the fiscal year.
Transaction: Amount and Timing
Every financial transaction in business has two equally important attributes – the amount and the timing. The date of the transaction is as important as the amount when it comes to preparing financial reports.
Financial reports are either for a period of time, such as the Earnings Statement which is for a quarter or fiscal year; or for an instant in time, such as the Balance Sheet which is for a specific date. When the transaction occurs will determine which report the transaction is recorded in.
It is often much easier change the date of a transaction than it is to change the amount of the transaction. I have often been asked to delay expenses near the end of a quarter or year. I have also been asked at times to accelerate expenses into the quarter or year. In both cases, we are managing the date of the transaction, not the amount of the transaction.
One other point about timing. The date for a transaction can be set either using the cash basis or accrual basis. The cash basis sets the date when the money changes hands. The accrual basis sets the date when the responsibility for what the transaction represents is transferred – such as the product is shipped or the material is received. Most businesses use the accrual basis. That way, if cash payments are hung up for some reason, the sales and costs are still recorded and a true reflection of the business activity will be shown in the report. The differences between the cash and accrual basis can be reconciled by analyzing the Cash Flow Statement.
Projects: The Financial System Relief Valve
Senior management must often forecast what they think will be the profit for the upcoming quarter or year. If the actual amount is significantly different, the owners and investors begin to worry that management doesn’t know what is happening. Therefore, senior management carefully considers the forecast they provide and they attempt to manage the business so as to meet the forecast.
But life happens. Inevitably something occurs to cause the numbers to be different than expected. There is an unexpected economic downturn. Competition surprises the market with a new product. The cost of raw material is higher, or lower, than expected.
Let’s look at the major elements of the Earnings Statement, which shows the profit earned during a time period. We want to see what can be done to influence profit as we approach the end of the fiscal year. We will assume that Finance has done a preliminary analysis and determined that the company may miss its profit forecast and is trying to find a way to increase profit. Our timing is set using the accrual basis.
- Revenue: This is sales in the marketplace. A company can increase sales near the year end through a promotion. But that may take time to set up and often results in less profit because of the cost of the promotion or discount. So that doesn’t help to increase profit in the short term.
- COGS: The Cost of Goods Sold is the variable cost associated with the product. It is the raw material and labor required to make product, or deliver the service. There are two things that contribute to this cost, volume and design. With respect to volume, if we sell more we must make more, if we sell less, we don’t need to make as many. However, in the short term, we must follow the sales orders. With respect to design, we could redesign for lower material costs or less labor, but that will take time to do the redesign, and if we are one month away from the end of the fiscal year, there is little that can be changed. So this doesn’t help us increase profit in the short term either.
- Fixed and Overhead Cost: When we consider the operating expenses of the business, we find that they behave in several ways. One is as fixed and overhead costs. These are costs that are required to run or sustain the business. They will not change based upon the day-to-day business activity. For instance items like rent, insurance, debt payments, or business license are typically based upon contracts or regulations. And business overhead functions such as the HR department, the IT department, the mail room, or the security guard are required to be at work whenever we open the doors. These can only be changed through business restructuring, which again cannot be done in the short term.
- Project and Program Cost: Which brings us to the last category, projects and programs. These are the expenses required to complete project and programs. These are normally scheduled based upon the project schedule, not the fiscal calendar. The fiscal calendar is something that management can’t change. However, a project schedule can be changed with a phone call from the project sponsor to the project manager. These are the only costs that can be changed in the short term.
So when Finance determines that the company needs more profit to meet its forecast, it is projects that get the call to stop spending. Projects are the financial relief valve for the business as it nears the end of a fiscal quarter or year. And if the year is going better than expected, the projects may be asked to accelerate spending. Yes it impacts the project schedule, but the project is sacrificed for the greater good of the business.