How many times have you reviewed financial performance or weekly cash flow budget to actual reporting and heard this explanation – “It’s a timing difference”. That excuse is a lazy explanation for not hitting performance targets and showcases a lack of curiosity in financial analysis. This lack of curiosity could be a result of not understanding how income statement and balance sheets work together, or not wanting to question people in positions of power, or not understanding the cash flow impacts of variances between budget and actual performance.
The most basic question that arises from the “timing difference” explanation is:
Does timing mean this variance is a permanent variance for the week, the month, the quarter, or the year?
If it is a permanent variance, what does mean for the yearly forecast, weekly cash flow needs, and covenant compliance? What will happen to working capital?
If it is not a permanent variance, when will the variance come back in line with the forecast and what will be the impact on cash flow and loan covenants while the variance exists? What will happen to working capital?
Moving past the basic question related to timing noted above, the analyst will need to understand the way the income statement and balance sheet work together, and what variances from budget to actual in one account mean to expectations for other accounts. A solid understanding of these inter relationships will allow the analyst to ask questions which identify what a timing difference means to overall cash flow, working capital, financial performance, and covenant compliance.
Financial performance analysis curiosity rooted in a solid understanding of financial reporting and cash flow and working capital management is necessary to develop the next level of questions. Let’s explore the questions to ask when you hear “timing” and you have already asked if the variance is permanent for some reporting period.
For example, if sales were lower than forecast, the further drill down questions would include:
· Were sales lower in the current month, but will be increased in a future month?
· Were overall sales lost for the quarter or the year?
· Were expenses reduced because sales were lower?
· Did inventory increase because production continued when sales were lower?
· How will future cash receipts be impacted?
· Will there be a cash pinch point because of the lower sales?
If cash receipts were lower than forecast, drill down questions would be:
· What is the aging of accounts receivable reporting?
· Were payment terms extended?
· Were sales below plan? If so, when?
· Have customers reduced their purchase plans?
· What payments were not made because cash receipts were lower than expected?
· What will happen to the next borrowing base certificate because of slower payments?
If labor costs are higher than expected drill down questions would be:
· Were commissions or bonuses paid? If so, why weren’t they forecast?
· Did production volume increase?
· Did the timing on payroll change? Were all payroll taxes paid on time?
· Did the number of employees change? If so, why?
· Was overtime increased? If so, why?
If utility costs were lower than expected drill down questions would be:
· Were all utility bills paid on time?
· What utilities were not paid that were forecast to be paid?
· What is the accounts payable aging reporting for all utility providers?
· Have any cut off notices been received?
These examples show what a deeper curiosity in questioning can uncover to provide real explanations for “timing differences”. When working with a company, it is important to follow up the “timing” excuse with the basic level of permanency, and then utilize the drill down questions to uncover what happened and how the future will be impacted.
When we have used the drill down question approach, we have been able to identify early indicators of changes in the business that allow the management team and the stakeholders to respond in time to impact financial performance and reduce the stress on cash flow and working capital management.