QUESTIONS

Based on his experience in preparing internal management reports over the last 20 years, Geoff is interested in discussing questions with other accountants wishing to set up or improve internal management reporting services for their clients or for their own firms. Examples follow.

Example Questions on Internal Management Reporting

Q	What information should be included in internal management reports?
A	We believe the data to include varies with the organisation and situation. Our approach is to consider the following:
	1. 2. 3. 4.	perceived needs of parties involved; and plans of the organisation; and conditions facing the organisation; and costs of collection.
Q	Why use spreadsheets, rather than a tested package, to develop reports?
A	Answers to the following criticisms of spreadsheets are tabled:
	1.	Criticism 1: "Spreadsheets may incur mechanical errors, particularly in data entry, with severe consequential errors"; Countermeasures: Data is routinely and automatically checked on entry, both as to arithmetical accuracy and as to reasonableness in magnitude.
	2.	Criticism 2: "Spreadsheets include logic errors due to inappropriate algorithms being used"; Countermeasures: the spreadsheets used follow a specific structure using standard formulae tested in previous trials before release.
	3.	Criticism 3: "Spreadsheets are subject to omission errors with some components of a model omitted completely"; Countermeasures: the strong internal control inherent in the structure of these spreadsheets guards against omission of data.
	4.	Criticism 4: "Spreadsheets often contain macros, requiring programmers to interpret and amend them, and exposing the organisation to viruses"; Countermeasures: no macros are used in these spreadsheets, which rely on a systematic structure and templates.
	A range of criticisms of packaged software could be levied: the packaged software reports are often inadequate without specialised programming support; they are often inflexible for the end-user to change to allow for unique organisation features, or for changes in requirements from one year to the next; the packaged reports are output from a black box, with no means of checking the source of data included; the packaged reports are subject to programming errors; the packaged reports may omit some non-financial features of a model; etc. Who wants to keep running back to a programmer every time a change in reports is required? If packaged software was so good, spreadsheets would not be so popular.
Q	What is the best response to executive(s) pressure for ambitious forecasts in connection with a specific decision?
A	Our view is that the person providing management reports has a professional responsibility to present a balanced view to organization executives, and to present alternative scenarios on occasion. An example is a manufacturing operation, where an executive asks for approval to purchase new equipment that he believes will result in greatly increased sales. The executive is very confident that use of the new equipment will result in sales "really taking off". He relies on his knowledge and experience of the customers and competitors, and has no objective evidence. The executive believes that papers to go to the Board of Directors, to support the decision to buy the new equipment, should include forecasts based on purchase of the new equipment, and a high growth rate in sales. We believe that the Board needs to get a balanced view, and to have alternatives, including a "do nothing" option. It is also important that whatever forecasts are put to the Board have the key assumptions clearly stated. A preferable approach in this situation in our view is to provide executives with a comparison of three scenarios, each of which is possible, and clearly label the key assumptions for the forecasts in each scenario:
	1. 2. 3.	Expansion Scenario. Modified Steady State Scenario. Stagnation Scenario.
Q	What policy on ownership of data should be followed in routine internal management reports?
A	Our advice is that the person supplying internal management reports has a professional responsibility to question the data in the reports, and to be comfortable that the reports are realistic and complete as far as can be reasonably assessed. This entails a need to ask questions on the data supplied, to check the consistency of it with other data available within and outside the organisation, and to comment in writing to recipients on the sources of the data, on significant assumptions, and on weaknesses in internal control. The data in internal management reports cannot be guaranteed to be accurate, but it can and should be questioned by the supplier of the reports before that person(s) pass it on to executives who will rely on it, and time needs to be allowed for this. As far as forecasts to be included in routine management reports, it is important that the supplier of the reports is comfortable that the forecasts are realistic, understands how they are made if not prepared by the supplier of the reports, and includes key assumptions of the forecasts as a note on the reports.
Q	How do you appraise the accuracy of forecasting?
A	Statisticians often used R-squared as a measure of goodness of fit. Geoff suggests a measure called the Absolute Percentage Error (APE) be used, defined as follows:
	This gives a result that is more meaningful than R-squared for the average person in business. For example, most persons in business will readily comprehend a statement that, on average for the year to 30 June 2002, actual monthly profit was within 10% of monthly budgets. In this case the denominator in the fraction above would be the sum of the absolute values of monthly budget profits.
Q	How can the MAF approach improve forecasting accuracy?
A	One important way that MAF may obtain improvement in accuracy in forecasting will be from disaggregation of data. Spreadsheets are ideal in providing the flexibility required for disaggregation. An obvious example is forecasting cash at bank: forecasting accuracy will usually be improved if separate trends in sales collections and overhead expenses are analysed, and then forecast, rather than trying to predict cash at bank direct from past cash at bank figures. Another example is forecasting profit: forecasts based on both operational and financial data are more accurate, rather than forecasting profit as an extrapolation of past profit figures. Look at the numbers of items sold, the numbers of people employed, and the year-end financial journal entries in the closing and opening months of each year. Another example is forecasting sales: forecasting accuracy may be improved if the sales are related to general economic trends, company pricing data, market growth data, and customer returns, rather than trying to forecast sales as a simple regression on a single series.
Q	What accuracy in forecasting may be expected?
A	Measuring forecasting error as the absolute difference between the year-end result and the forecast result, the following may be expected:
	1.	Accuracy will vary with volatility of the series being studied. It is more important to steadily reduce forecasting error, and to learn from one's mistakes, than to judge forecasting success against arbitrary standards.
	2.	Forecast annual results will hopefully converge to the final actual result, as the year progresses. For example an 11% error in a forecast of sales for the full year, made at the beginning of the year, reduced to a 3% error when forecast half way through the year.
	3.	One cannot expect to predict System Shocks, associated with unexpected shake-ups to the economic or political system.
Q	Who can best set up internal management reporting for an organization?
A	Kaplan and Norton noted in their book "The Balanced Scorecard" 1996 on page 290, in discussing ownership of the strategic management system: "Most organizations today have a leadership void for this system. No executive in a traditional organization has the responsibility or perspective to manage a strategic management process, and it is unclear who should assume this responsibility." Organizationally accountants are well placed, but will incur difficulties in meeting the challenges of (i) strategic planning for the entire organization; (ii) forecasting; (iii) finding the time, with increasing compliance responsibilities.
Further Steps:
	Take the opportunity to obtain free advice. In return for completing a poll of 8 questions, you can raise a discussion question for comments.
	Take the opportunity to request a free newsletter. In return for completing the poll of 8 questions, you can request a newsletter on Management Reports.
	A free quotation may be obtained by completing the poll of 8 questions. A summary of the basis of the internal management reports service will be supplied to interested parties.
	Based upon information supplied and a quotation, the report service may be ordered. An initial term of 3 months (for monthly reports) may be followed by agreement on a longer term if the client is satisfied with the reports. Or a 12 months term can be agreed at the start.