Sales departments had better be ready for in 2005 they are going to be under scrutiny as never before. To understand why, you only need to look at events across the pond. November 2004 has been a watershed in the world of corporate governance. In the US, executives involved in the Enron scandal were convicted of fraud at the beginning of the month. Two weeks later, new stringent rules for corporate reporting, which were born out of the above, kicked in.
The Sarbanes-Oxley Act has been introduced to protect investors by preventing illegal accounting schemes being used to pump up the appearance of financial success. The US law has huge implications for UK grocery.
November 15 marked the deadline for Sarbanes-Oxley compliance for US public companies that report earnings prior to December 31 this year. Some of the biggest names in grocery are being forced to go through their accounting systems with a fine toothcomb to ensure they are compliant and that there are no weaknesses in their controls. Many have European divisions and are likely to drive compliance throughout their businesses. Think Wal-Mart, Heinz, Kraft and Procter & Gamble among others.
But the events in the States have had another effect - they have thrown the spotlight firmly on to internal financial structures, or lack of them.
While there is no suggestion anyone in this industry is doing anything illegal, grocery is not free of black holes when it comes to financial accounting. And the most obvious is in the area of trade investment, the monies invested by consumer product companies into their retail and wholesale customers. This is an area which has seen expenditure more than treble over the past 20 years so that it is now typically a manufacturer’s second largest item of spend, equating to 15-30% of its gross sales revenue.
It is also an area over which many consumer packaged goods companies admit in private they have no internal control. You only need look back at the saga of cider manufacturer Bulmers, which blamed unexpected promotional costs for the black hole in its accounts.
Aidan Bocci, MD of specialist consultants Commercial Advantage, points to one company that had overspent its budget by the end of the year. “No one knew where the overspend had gone. The finance director could not understand it.”
The introduction of new International Accounting Standards on January 1 will intensify the scrutiny even further. These are designed to force ambiguities such as those outlined in our example out of the accounting system (see box).
These new rules raise the visibility
of trade spend and how companies state it. Compliance with Sarbanes-Oxley section 404 means “what you commit to is what you execute and what you finally settle”. In grocery this translates to demonstrating that you have adequate internal controls of your trade promotion processes among other things.
“Financial directors of major CPG companies will be confident that they have pared down organisational and supply chain costs, but their trade promotion spend is often much more difficult to control,” says John Whitehead, vice president, sales, of trade promotions management systems provider CAS UK. “This is not least because of the vast numbers of stakeholders involved both within and outside the business.”
He expects to see an increase in the adoption of trade promotions management (TPM) systems as manufacturers look to get greater transparency, flexibility and accuracy of data. And, as CAS’s experience has shown, both the sales director and finance director are likely to be involved as sponsors of such projects. “An effective TPM system expedites the flow of information between functions and between trading partners. It thus enables more strategic thinking so that finance directors can look beyond the immediate goal of reducing costs to the improvement of revenue and profit from trade promotions,” says Whitehead.
As he points out, it is not just controlling costs that is interesting financial directors. Trade investment is permeated by poor controls, be it the inadequate return on investment measures or the apparent inability of retailers to execute properly in-store when it comes to availability and promotional compliance.
Giles Lee, finance director of adult soft drinks supplier Shloer, says: “Given that there has been so much publicity about the waste from availability and compliance issues, and the lack of serious initiatives, it is only surprising that finance directors have not taken an interest before.”
Storecheck Marketing, which provides an in-store profit management service, says one of its most enthusiastic clients is a finance director. “He is not at all surprised to see something of a power shift away from sales and marketing. It is possible this shift will become more permanent unless the sales and marketing functions become really serious about measuring the way they choose to invest. Merely linking to last year’s budgets will not be enough,” says managing director Colin Harper. But James George, director at strategy consultants OC&C, says companies need to work hard to make the different internal functions sing from the same hymnsheet. “There is a tension between sales, marketing and finance and this is one of the key reasons why this area has been so badly managed. Each department concerned has a major vested interested and no one individual has sole responsibility. Companies need to wake up to the fact that this is a business issue, not one for the sales team.”
According to PricewaterhouseCoopers, we are seeing the beginning of a new trend where maximum corporate transparency is demanded in order to quell the fears of investors. This will naturally entail increased pressure on companies to provide better information faster.
But there is still a considerable way to go. “We stand at the foot of a learning curve that has to be climbed - and fairly rapidly,” says Whitehead. “Those companies that have already adopted TPM are seeing the tangible benefits of their investment. Others must surely follow.”
>>manipulating the figures
Company A sells an item for £100 that cost £30 to make. The operating profit is therefore £70. If general expenses are £30, then the net profit is £40.
Suppose company A decides to bolster sales with a trade promotions package.
It therefore sells the item at £85, giving an operating profit of £55 and a net profit of £25.
Under existing standards, company B could ‘massage’ the same figures by keeping income registered on the balance sheet as £100 and adding the £15 difference to the expenses figure. This would give an operating profit of £70 and a net profit of £25.
The end result is the same - £25 net profit - but if you only focus on income and operating profit, you will be fooled into thinking company B is healthier than it actually is.