You’re on a board. You’re not financially trained but you appreciate that reviewing finances to ensure they’re under control is an important aspect of good governance. What should you be looking for? What are the questions to ask? Is there a “cheat sheet” or checklist?
I received an email recently that asked “what should I be looking for?” In our experience as accountants who advise a wide variety of organisations, it’s a reasonably common question. Usually it’s asked by people in governance roles who don’t see themselves as having strong financial acumen but who want to do a good job in their role for their organisation. Interestingly the question is much more common in relation to not-for-profit (NFP) and charitable entities than profit seeking commercial organisations.
However while the question is reasonably short, the answer sadly, is not. Nor is it nearly as simple or concise.
The reason is context.
In order to answer the question and assist those board member(s) seeking help, it’s important we understand key factors which include the:
- Purpose, nature and complexity of the organisation in question
- Experience and level of general financial knowledge of the board member(s) asking the questions
- Level of financial resources and competencies within the organisation and the board
Given the breadth and depth of “finance” as a subject, the hope of a “one size fits all” checklist or quick “cheat sheet” is a tad unrealistic.
Don’t ignore the dollars because it’s too hard
Just because it is hard doesn’t mean the issue can be ignored.
There’s no doubt the financial health of any entity is of significant importance. For profit-driven commercial organisations, profit and financial health is a primary focus and a key measure of success.
NFP/charitable organisations are understandably more concerned about purpose than profit. But their financial health while not a primary aim, remains important, for without it they are unlikely to have the necessary resources to be able to deliver on their purpose, or in some cases even survive at all. The fact finances aren’t usually a key purpose, is a reason to have more focus in this area.
So what do governing body members need to know and focus on?
Good monitoring of finances is all about understanding and awareness – specifically of what should be happening, what is happening, and why.
This monitoring and any corrective action also needs to be on a timely basis. Like a ship taking on water; if the leak is identified early the flow can often be halted. Left too late and the impact of all the water on board may well sink the ship.
Board members need to understand at an appropriate strategic level, what the economic drivers are of the entity they are governing. For the majority of governance this requires general interest and understanding rather than a deep specialist level of accounting knowledge.
For example within a trading concern, board members need to understand the nature of the trading process and financial cycle. When do costs occur? Do we carry stock and the implications of this? When do we receive income and are there any collectability concerns? How do we fund the fixed assets and other resources needed to carry out the production and trading?
Contrast this with an NFP that is likely funded by grants and donations. Their questions are very different; when do we receive funding? Is it in lumps or spread evenly over the year? Is it in advance of costs or after? If after, how do we fund the timing shortfall? How secure is our funding? Is it a multi-year contract or one-off? Where are the cost levers we can pull if we have to within our flexible versus fixed costs?
Once the economic drivers are understood then boards need to understand what the desired or expected results are. A profit of $1m may be a fantastic result - or a disaster. It all depends upon what scale of operation is required to generate this and what the expected return on the investment is. Herein lies the importance of creating and utilising detailed budgets. If there’s confidence in the quality of the budgeting process from past experience, and good quality of management and systems, then monitoring against the approved budget by a board can be a simple variance analysis. Boards will therefore invest their time and effort just focusing on variances outside set parameters.
The terminology for what is measured is often known as key performance indicators (KPIs). KPIs report on key economic drivers and measures of financial performance and position and can be summarised in dashboard reports allowing boards to assess the levels of key measures quickly and easily.
Again there’s no “one size fits all” list of KPIs. They’re contextual. The process of developing appropriate KPIs for an organisation can be an extremely valuable for board members to be involved in because it will greatly enhance their understanding and awareness of the economic drivers of their organisation. It should also help boards ensure the connection to their organisation’s strategy and allow effective monitoring of progress towards that. While not all KPIs will be financial in nature, many will.
Cash flow vs profit or surplus
This is a topic that requires a special warning. While profit or surplus is generally important for the ongoing growth and financial sustainability of any organisation, cash flow is critical.
The best analogy for this is that profit can be likened to food and water for humans. It is necessary to sustain life but you can actually survive for a while without food or water as long as this is not a long-term situation. However, cash flow is more akin to oxygen; you can’t survive for very long without it!
The other important understanding is that growth generally costs money because entities are required to invest in new people and resources in order to create the future income and ultimately profit that they desire. However while the costs are immediate, the results generally don’t come immediately. This explains the conundrum of why seemingly profitable high growth entities often go out of business. They simply run out of operational oxygen.
Hence boards should not only monitor their profit or loss account but also have a timely overview and understanding of cash flow implications of their entity’s operations.
And finally some board member fundamentals
A great board member has something in common with a typical four year old – the art of asking the simple, direct questions“What’s this?” and “Why?”
Boards should be able to rely on management to explain the information presented to them.If financial information is not presented in an understandable way then boards should request reports are modified to their satisfaction. There’s no ‘best’ format.Instead this will differ depending upon the context of the organisation (nature, scale, complexity etc) and understanding levels of the board members.
In our experience far too many boards allow management to present copious quantities of financial information without rigorously querying this.Good quality financial information is often subsumed by the volume of financial information presented. This leads to the ‘glazed-eye’ effect and true financial analysis suffers.Boards hold the power to request and receive the information they desire and need.If they aren’t getting it then they have the power to address that.No excuses.
Board members don’t need to be accountants or have extensive financial training in order to be competent in their financial oversight role, albeit some financial training is always useful to improve one’s knowledge and skills. However, board members must understand the context and economic drivers of their organisation and the expected results to identify when things are going off course so corrective action can be taken.
And finally as auditors, it would be remiss of us not to note that if the entity is audited, then boards need to be proactively involved to ensure they are receiving the most value from that relationship. But that is the topic of a future article...