Which statement is true?
1. To properly manage your company and maximize value, you need to have good processes or controls.
2. To properly manage your company and maximize value, you need to have good processes and controls.
The answer is statement 2. Why? After all, at first glance, both statements appear to say the same thing. In fact, each has a distinct meaning and a significant, if subtle, difference.
Statement 1 implies that processes and controls are the same thing, that the words are synonymous. However, processes and controls are not at all the same and each one has an important impact on the overall value of your company.
First, let's look at controls. I am not referring here to the operational sense, where controls are mechanical or electronic devices that ensure a production process runs as intended. Instead, I am talking about the financial, or more correctly, the accounting definition of the word. In that sense, controls are defined as procedures used to assure accuracy in the record keeping function. You have controls to make sure that all financial transactions are recorded and that they are recorded in a proper and consistent manner.
When we attempt to place a value on a company, we base our value in part on an analysis of the company's financial data. How do we know the financial information is accurate? We rely on the assumption that the company has financial controls in place, and that those financial controls have been reviewed by a CPA to ensure that the accounting controls are in place and are enforced by the company.
Accounting controls only give us a partial picture, however, because all they tell us is that the company is giving us numbers that are accurate. When we value a company, though, we also want to know how well managed the company is and for that we must look at the company's processes. Specifically, we want to know just how efficiently and effectively the company operates--how well can the company operate on its own without the need for constant intervention by the business owner or management team?
I will illustrate with an example, but first let's define what we mean by a process. Simply put, a process is a series of procedures or activities that are taken by employees to achieve a specific goal established by management. To maximize a company's value, you not only need processes, but the processes must be both efficient (get the job done quickly) and effective (get the job done).
To clarify the difference between controls and processes, let's take the simple example of filling a sales order. The normal process would be as follows:
1. A purchase order is received from your customer, and the customer requests credit terms.
2. The purchase order is sent to the credit manager for approval.
3. The credit manager reviews the request, approves the order and sends it to the production department.
4. The production department reviews the purchase order because the production manager cannot order inventory or begin the production process unless the order has the credit manager's approval. After noting that the credit manager's approval on the order, the production manager issues his own purchase order for inventory and sends the order to the purchasing manager for approval.
The preceding sequence includes a number of accounting controls. Inventory cannot be ordered without the credit manager approval and no money can be spent to purchase inventory without the purchasing manager's approval. At the same time, you will note that the purchasing manager is not able to approve payment without a signed purchase order from the production manager.
So, from an accounting perspective, the CPA will come in and review the preceding sequence and examine the company's financial records to verify that the procedures are adequate and to confirm that the procedures are being followed. That is the control aspect.
The process perspective would be examined perhaps by a CPA or perhaps by another individual, such as the chief operating officer. Instead of asking if controls are in place and if they are being followed, the COO will look at the sequence of events and try to determine if things can be done faster, better and with less cost. So, when reviewing the preceding procedures, the COO may ask such things as:
1. How much time does it take for the purchase order to go from sales to the credit manager? Can the purchase order be delivered to both places at the same time?
2. How long does it take the purchase order to receive credit approval? What are the steps the credit manager takes to determine if he will approve a purchase order? Can some credit approval limit be delegated to the sales area to speed up the process and reduce the workload on the credit manager?
3. Is it possible to automate the process in any way? For example, once the credit manager gives his approval, can the computer system automatically generate a purchase order for the production manager to approve rather than having the production manager spend the time to create one?
4. How many days can we save on the entire process?
Any improvement in efficiency or effectiveness will speed up the entire process and ultimately result in lower costs and higher profits, which can only increase the overall value of the company.
So remember, as you work on improving the value of your company, focus not only on having the proper financial controls in places, but also on making sure that your financial processes are as efficient and effective as they can possibly be.
