The issue has come to the fore in Canada, where the recent fluctuations of commodities prices have made it difficult for the many national producers to make projections. Bill Dillabough, a partner with KPMG's Audit Committee Institute in Toronto, discusses the issue.
Have audit committees become more attentive to forecasts and budgeting than they have been in the past?
Yes, it's clear that audit committees see a need to look much more closely at budgets and forecasts than they did in the past. There is a general feeling, not just post-crisis but actually going back to Enron, that any risks in these areas should be carefully controlled. I've been impressed by the diligence that audit committees have applied to this area.
Has the recent extreme market volatility made this more difficult?
The wild swings on the capital and commodities markets have, of course, made management's work in developing forecasts and budgets much more challenging. The price of oil, for example, has gone from US$147 per barrel in July 2008 to about $30 per barrel last February and now back up to about $70 per barrel. That's a lot of change in less than a year. Similarly, working out the impact of the fluctuation in foreign-exchange rates has been extremely difficult. The value of the dollar versus the yen or the euro moves markedly almost every week. A stronger dollar obviously hits profit on exports, but how can managers determine how much to expect in a quarter?
But even ordinarily straightforward projections are difficult to make in this period. Consider forecasts for automobile sales: Is it really possible to have a clear idea of what they will be in the next six months? Or how much production there will be as producers slash jobs and close plants? What's happened is that the number of variables has gone through the roof.
And audit committees are trying to track all the variables?
Audit committees are questioning management closely about the processes employed in making forecasts and budgets. They are paying close attention to the assumptions made, to how sensitivities are determined, and to contingencies. As part of this effort, many audit committees have increased the number of informal meetings with the CFO and other managers. The questions audit committees are asking about forecasts include:
- what are assumptions based on?
- how was the data compiled?
- how reliable are the models used?
- has the horizon scanning been broad enough?
- do the scenarios adopted allow for rapid change?
What about budgets?
Dillabough: Budgeting is even more complex, because most companies do a ‘bottom-up’ and a ‘top-down’ budget draft. Rates of growth are projected both by the sales force and by top management, and then those projections are compared. But the extreme market volatility has made the variables in budgets very difficult to determine. That means any sort of growth projection must be subject to extremely detailed scrutiny by the audit committee.
The audit committee should try to follow the entire budget process as closely as possible. The audit committee will typically want to know: What factors went into the development of the budget? What controls are in place? Has adequate consideration been given to the cost of credit, and how it might change? The relationship of all business to lenders has become very difficult. Debt is also increasingly difficult to value.
The sensitivities for the budget have become much larger. It used to be that companies would expect to miss a budget by a few percentage points, but now it's not uncommon for a company to miss by a much larger amount. The ramifications for the business are huge, and the audit committee should explore all aspects of the process.
Are there new areas that audit committees are focusing on?
: The need is being seen for managing risks at much broader levels than before. For example, some audit committees are looking at the company's customers, and examining the customers' exposure to risks. Audit committees also are asking about the company's other key business partners and whether those partners and their risks are likely to experience rapid change. Another area audit committees are considering is insurance. Who is the carrier? What risks is the carrier exposed to? Will the carrier remain liquid?
The banks that a company works with are, not surprisingly, subject to the most scrutiny by audit committees. Will the bank survive? Are the banks in a position to renew the company's facilities or even honor existing facilities? Will a bank's work be restricted by exposure to government loans with their attendant regulations? These are just a few areas where audit committees must begin to show increasing vigilance.
Previously published in ACI Insights — July 2009
The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG’s network of firms.