The budget process still requires a lot of time and effort, which risks creating an outdated...
Companies worldwide often face various, often unknown circumstances in volatile modern environments. These are temporary opportunities or threats that might substantially impact financial results.
Often, the management of companies facing these challenges prefers to highlight individual figures in financial reporting related to the phenomena in question. This allows them to study financial implications separately and avoid diluting data on temporary effects and business as usual.
This article considers a case study from a laboratory testing company, which seized an external opportunity to support public health authorities and societies in the fight against the COVID-19 pandemic by launching a PCR testing programme between 2020-2022. Although this case study focuses on just one example, the practices, considerations, and lessons from this study could be applied to any temporary circumstances, whether an opportunity or a threat.
Lesson 1: Isolate The COVID-19 Financials
A global laboratory testing network company began offering COVID-19 PCR testing services in Q1 of 2020. At the time, the company’s financial system was not fully set up to allow effective tracking of the key financial indicators related to this growing and unprecedented COVID-19-related activity across its laboratories worldwide. Therefore, the HQ Finance team manually collected data from each sales department to provide a representative overview which could sufficiently inform the management of the network and stakeholders, such as investors.
As the scale of COVID-19-related activities the network engaged in rapidly increased, it soon became clear that manual data collection and analysis were insufficient to inform effective decision-making. Manually collected data lacked depth and consistency. This led to the decision to create separate units within the structure of the laboratory testing network dedicated to COVID-19 testing. Internally referred to as “business units”, they were profit centres with separate profit and loss statements.
It allowed the HQ Finance team to achieve three primary goals:
- Make it easier to perform controlling COVID-19 activities.
- Keep track of the testing network’s core business (non-COVID-19-related activity).
- Have precise data that could be communicated to essential stakeholders.
When a company starts a particular business activity, it wants to ensure that it is profitable in the long run. It is difficult to achieve without a reliable P&L. The establishment of separate COVID-19 profit centres made it possible to track every P&L statement and to validate the performance of given Business Units properly. More importantly, if such ad-hoc activities had not been isolated, their numbers would remain in the structure of the main business, diluting the performance of the regular exercise. This, in turn, would have raised questions from internal and external stakeholders who wanted to know whether a fluctuation in performance across varying testing activities was temporary or long-term, where it had come from and how efficient the new activities were.
Lesson 2: Align Historical COVID-19 Numbers
Once the new profit centres were established and were recording monthly COVID-19-related financial statements, it became clear that they had come along too late. There were approximately six months of COVID-19 testing between the first test carried out and the establishment of the dedicated profit centres that were unaccounted for systematically and isolatedly. That is to say that six periods in the financial system reported mixed financial indicators, containing both COVID-19 and non-COVID-19 numbers. It is impossible to properly plan and analyse if the entire year's data set is not fully aligned. In order to ensure a proper comparison of numbers between past, present and future periods, the finance team had to find a way to separate the 6-month period in question to reflect the correct split of various activities across the laboratory testing network.
Financial rules and regulations do not allow companies to change the reported financial numbers in closed periods. Therefore, the team had to perform this separation in another module within the financial system to keep the officially reported numbers untouched.
At the time of this exercise, hundreds of business units across the laboratory testing network were involved in COVID-19 testing worldwide. In many cases, numbers had to be subtracted from multiple sources worldwide and added to only one new COVID-19 profit centre. Furthermore, hundreds of P&L accounts with different +/- signs had to be split up in each business unit.
An undertaking at this scale and with many variables dramatically increases the risk of errors. The impact of any mistakes would be significant and detrimental. Not only would the new COVID-19 figures become warped, but so would the financial reporting related to the laboratory testing network’s core business numbers (non-COVID-19-related activity).
Lesson 3: Develop a COVID-19 Budget
Developing a separate COVID-19 activity and non-COVID-19 activity budget was important for two reasons. First, it allowed the Finance Team to track regular business performance against the corresponding “clean” budget. Secondly, it allowed business leaders with some COVID-19 business units to set fair performance targets in their scope of responsibility. COVID-19 revenues and costs are highly unpredictable and heavily depend on the course of the pandemic. It would be unfair to those leaders to link their performance with unknown variables.
At the same time, it was essential to ensure consistency in the COVID-19 budgeting approach across the network of testing laboratories: what exactly and how much should be separated from the regular business and moved into the COVID-19 business units. An inconsistent approach could lead to unfair financial advantages or disadvantages across the business units. It required a clear and well-defined Group Policy.
Since the budgeting process is closely tied to current and historical financial numbers, all historical numbers must be consistent and accurate. Separating historical data related to COVID-19 was essential in ensuring an effective budgeting process.
Lesson 4: Secure Safety Reserves for Potential Impairments
Since the duration and scope of COVID-19 activities are highly unpredictable, there is an inherent risk of high levels of capital investment and inventory building up for COVID-19 testing. If the pandemic had ended abruptly, it would have required a business to incur significant expenses related to the write-offs of assets and inventories that could no longer be used or sold. Under IFRS and GAAP, companies are required to spread the cost of assets across the useful revenue-generating life of these assets and incur expenses for the inventories the moment they are used to generate sales.
Therefore, in order to minimise the risks of large write-downs of assets and inventories at the end of the pandemic, the company decided to create special provisions for the impairment of assets and inventories related to COVID-19 activity. It was a large global project that required significant coordination from international teams as these bookings had to be carried out by the local in-market finance teams worldwide. In many cases, teams were tangibly resistant due to the complexities of local statutory requirements.
The four practices described above have allowed the laboratory testing network to completely isolate its COVID-19-related activities from the rest of its core business. It has allowed them to ensure that each activity type is planned correctly and analysed, create a budget that covers both parts separately and protect their future P&L from the risk of large write-offs.
Using separate profit centres for COVID-19 activities has demonstrated that setting up a flexible organisational structure in the financial system at an early stage is critical, as it allows for complex data analysis in the future. If the structure is not adaptable enough to quickly separate such activities, this is a cause for concern.
As business partners to the company, finance teams are uniquely positioned to provide incredibly valuable information to business leaders that can inform strategic decisions. Hopefully, these lessons will be helpful for any organisation experiencing a temporary effect/phenomenon that strongly impacts its financial performance. One could apply many of the learnings documented in this article to instances such as business shutdowns, acquisitions, natural disasters, cyber-attacks or business restructuring.