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Financial Accounting Outsourcing (FAO) Annual Report - January 2007

IT Outsourcing in the Small and Medium Businesses

The ever-tightening regulatory environment is an old story now. But in the first couple of years after the US passed the Sarbanes-Oxley (SOX) act into law, there was complete chaos in the market for finance and accounting outsourcing services. No one knew what the new regulations were or how to deal with them.

Now companies do understand what SOX is and how to achieve compliance. Yet understanding the relationship between SOX and finance and accounting outsourcing (FAO) is still not widely known.

As we see it, FAO facilitates regulatory compliance.

Meeting the new requirements for compliance and transparency requires significant funding at a time when increased global competition and rising energy costs are maintaining pressure to lower sales, general, and accounting (SG&A) costs. The November 4, 2004 issue of the CPA Journal estimated that SOX compliance alone is costing companies nearly US$1 million for each US$1 billion in revenue, of which auditing and technology are the largest expense categories.

Corporations have been setting up compliance in the face of an uncertain future. In the wake of SOX, a number of regulatory, enforcement, and oversight bodies enacted new guidelines, rules, and regulations. Without letting the dust settle on the legislation currently enacted, the US agencies continue to propose new rules. Therefore, the primary challenge is NOT in meeting the current requirements but rather in developing the agility required to efficiently respond to future requirements.

And top management is holding senior leaders increasingly accountable for the validity of financial statements, as well as for the controls and processes underpinning them. Today, decisions which affect financial processes are very visible (It has something to do with that go-to-jail clause in the new regulations).

Outsourcing: The Compelling Solution

There are a number of alternatives to tackle these complications:

1. Incremental improvements: Invest in incremental improvements for documentation, systems, and processes. However, given the magnitude of the problem, many companies have found incremental improvements were not sufficient.
2. Internal reengineering: Reengineer the organization and processes, potentially including a move to a centralized shared services model. Shared services was a great idea before the arrival of the FAO service providers. Today, however, CFOs are less inclined to invest in establishing internal organizations that are non-core when they have the option to leverage the investments the FAO suppliers have already made.
3. External assisted reengineering: Reengineer the organization and processes through FAO, which is today's solution of choice for many organizations.

Outsourcing is proving to be not only a feasible option but, for many companies, also the most compelling. Here's why.

A number of compliance efforts, such as process documentation, have always been a part of the outsourcing transition process. Therefore, from an outsourcing supplier's viewpoint, the efforts to document processes, develop and maintain an Operating Procedures manual, and manage a formal change control process, are already baked into their cost structure. They can therefore provide these benefits to outsourcing buyers at an effective cost. As a result, the financial attractiveness of FAO has actually increased as a result of the new compliance and transparency requirements.

In addition to the financial benefits, FAO helps in reducing the significant risks associated with organization and process reengineering, as outsourcing relationships treat services, service levels, and associated costs as contractual commitments. And finally, outsourcing helps to create the all important separation of duties that auditors look for.

Implications For Suppliers

In the backdrop of these transparency and compliance issues, meeting FAO buyer needs places a few key requirements on suppliers. Suppliers need to have a brand name, references, and trustworthiness in order to satisfy a buyer's CFO and/or board of directors. They need to exhibit success in change management, change control, systems integration, process re-engineering, transition management, workforce management, work flow, and document management. The financial strength of suppliers also becomes an important factor; buyers are performing due diligence on the suppliers' balance sheet strength and cash flow.

Going forward, we expect to see a greater supplier investment in compliance-related capabilities. While suppliers continue to increase the required new tools such as document management and work flow tools, they will also work to sharpen their message and become more forceful in communicating the idea that outsourcing facilitates improved transparency and compliance.

Is There A Catch?

Yes! The lack of maturity of FAO, combined with a new and changing regulatory environment, gives cause for uncertainty. Although the rigor inherent in third-party relationships (documentation, contracts, service agreements, segregation of duties, and audits) creates a natural improvement to compliance through outsourcing, the market remains immature, practices are continuing to evolve, and the messages from suppliers to buyers lacks clarity. Buyers can mitigate the risks of jumping into this immature-yet-rapidly-growing area with well-thought-out contract and governance structures.

Lessons from the Outsourcing Journal:

• An ever-tightening regulatory environment is driving the need for improved transparency and compliance. Compliance has become a senior management concern with visibility now pushed to the highest levels for decisions which affect financial processes.
• Companies have several options for implementing the new requirements: incremental improvements, internal reengineering, and outsourcing. Given the magnitude of this problem, many companies have found the incremental improvement alternative to be insufficient, and reengineering through internal shared services, rather than outsourcing, presents a significantly different risk profile.
• The financial attractiveness of FAO has actually increased as a result of the new compliance and transparency requirements. In addition to financial benefits, FAO contributes to meeting compliance requirements in a number of ways: lower costs, investment avoidance, new capabilities, and lower risk.
• Going forward, we expect to see more supplier investment in compliance tools and marketing. However, the lack of maturity of FAO, combined with a new and changing regulatory environment, creates uncertainty.

Publish Date: June 2006

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Copyright © 2006 - Everest Partners, L.P.

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