Over the last few months, we’ve seen a whole host of accounting misses come to the fore of the news agenda, none more so than that of Patisserie Valerie. The auditors of the cake chain reportedly missed a £20m black hole in its funding. With a stated cash at bank of just £21.5m, it’s no wonder the whole business, its management and auditors, have been pushed directly into the firing line.
How could the gap between the results and the reality be so material? There are a few issues that must be tackled – perhaps a little like locking the stable door after the horse has bolted for Patisserie Valerie, but it should be a gentle reminder for others to take on board before it’s too late.
Quality of audit
The spotlight in this particular case has fallen on the quality of the audit. It’s a prevalent issue, with other victims including Carillion and Conviviality. By all accounts, change is on the horizon and there can be no shying away from the fact that auditors need to dig deeper and probe further.
One of the most technologically exciting parts of this change will be the application of intelligent algorithms in a real-time audit environment, allowing management and accountants to spot easily where and when something isn’t quite right. We are not quite there yet, but before we get there are more fundamental issues at the heart of all this that should be addressed.
Quality of management information
It seems obvious, but it’s worth going back to the reason for accounting in the first place. Its purpose is to represent the financial performance of a business and report it externally to shareholders and internally for management decision making. The clarity that good accountancy can provide is absolutely vital. It’s therefore a little ironic that accounting treatments have become so complex that they can obscure the underlying performance of a business.
As a result of this complexity, it is becoming harder and harder to test the accounts to reveal the sorts of errors that should have been spotted by those at the top of the chain at Patisserie Valerie. Luke Johnson, the Executive Chairman, himself seemed unaware of the funding gap, which, to put into context, is equivalent nearly an entire year’s worth of pre-tax profits.
In this context, the failing is not that Mr Johnson couldn’t tell from the accounts what was going on, it is that the business cannot have had satisfactory management information to present that performance. Management information that stripped out all of the accounting noise and provided the executive team with a clear understanding of the true performance of the business, would have given them the ability to spot this issue far earlier.
Integration of reporting
This issue is compounded when there is too much disparity between management and financial accounting. Businesses must remember that both management and financial accounts are trying to achieve the same end result – to demonstrate business performance for the leadership team and shareholders.
Thanks to the impact of automation and AI, which will move many of the roles in finance from process driven to insight driven, it’s likely that in 10 years’ time this division will be far smaller. At that point, finance teams and auditors will see in real time how a business is performing, and when issues like this occur, algorithms will spot quickly that a change needs investigating. It will also allow for significant integration of management and financial accounts and make it exponentially harder for these sorts of issues to remain hidden for so long.
Put simply, accounting treatments have become so complex that they can obscure the deal performance of the business. Without good management information, the leadership team is flying blind. Yes, auditors should be trusted to do their jobs properly and thoroughly, and their performances should be subject to analysis and competition to ensure the best job is always being done. Yes, management teams should be probing and questioning and scrutinising their books. But at the end of the day, these things alone won’t fix the problem until management accounting is providing what it sets out to – clarity.
The funding gaps such as Patisserie Valerie’s are symptomatic of lack of understanding. When AI fully steps in and sophisticated algorithms do all the bean counting, it’ll be much easier to spot bucks in the trend, both because algorithms will flag that something is wrong and because finance will be largely focused on providing management with the right insight. When firms can achieve that, they’ll be far less at risk. Ignore these issues, and risk history repeating itself.