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Financial Modeling 4 Things to C.A.R.E.

IntroductionFrom their earliest abilities to automatically sum, algebraically transform and compile information, electronic spreadsheets have today transformed themselves to being a strong source of competitive advantage for businesses. They have enabled CFOs and financial analysts model the impact of financial transactions to improve decision-making support for deals, performance of investments and to analyze multiple financial scenarios for maximum success.

As highly competitive capital markets stepped up the pressure for accelerated decision making to model complex and creative financial transactions, spreadsheet models became more sophisticated - with inter & intra-linked worksheets supported with macros. They have become a core asset for many organizations, providing them with insights to improve their flexibility in responding to external needs.

There has, however been an equal, if not greater, price to pay for such flexibility. High-profile spreadsheet errors and spreadsheet fraud have emerged as major risks for many organizations. If this were not enough, studies report undetected errors in over 90% of surveyed spreadsheets.

Do such risks arise merely from the practices used to develop and manage models? Or are they due to the inherent structure of spreadsheets? Whatever be the reason, they point to a dangerous lack of transparency that make them notoriously difficult to audit.

Financial analysts today face performance pressures and challenges of tremendous complexity. The concurrent play of market factors (globalization, proliferation of financial instruments, dynamic regulatory mandates, fluctuating capital) have created a cascading effect that need them to process increasingly complex analyses in lesser timelines and with greater numbers of involved parties.

As a result, analysts are forced to trade-off between quality and timeliness that lead to greater risk of errors. In their attempts to accelerate the financial modeling process, they find themselves seriously constrained by the limitations of the functionality available in their current spreadsheet technology.

What is needed is the efficiency of an effective financial modeling tool that features rapid prototyping, high level modeling and analysis, and an increased transparency in model formulas and model structure. This, in turn, will shift the focus from data manipulation to authentic analysis and decision-making with data integrity.

Advances in spreadsheet technology are still inherently limited by the underlying grid-based metaphor. This does not permit key technological advances like high-level model hierarchies, classifications, and abstraction to be incorporated. Clearly, an entirely new financial modeling platform is needed to address today’s financial analysis requirements.

CFOs, CIOs and CROs have consensual concerns. How do we eliminate the extreme vulnerability of the spreadsheet’s risk of exposure? How can we move our financial modeling into a well-controlled environment with effective processes to assure integrity of reporting, governance and business decisions? How can our organization be meticulously compliant with regulatory mandates and seen to be transparently so? Can our model be scalable for dynamic market and regulatory changes? How can we enhance the return on investment to bring cost efficiencies in maintaining unwieldy spreadsheets and loads on email servers?

Clearly, what is required is a new modeling platform that C.A.R.E.s to fulfill the following crucial asks

COMPLIANCE – with regulatory

requirements

ASSURANCE – on the integrity of financial

reporting and consequent business

decisions

RETURN ON INVESTMENT

EFFECTIVE PROCESSES

The C of C.A.R.E - Compliance

The risks posed by both operational and modeling spreadsheets are neither new nor unacknowledged. However, today’s stringent regulatory climate is punishing of even mild acceptance to such risks.

Regulatory legislation demands integrity of end-to-end finance operations. It asks organizations to implement and document internal controls to ensure such integrity. Further, it holds business accountable if executives and employees do not adhere to any regulatory policies and procedures.

An effective solution to address statutory requirements should thus eliminate vulnerability to error and fraud by making user interactions transparent to the organization and auditors. Such spreadsheet integrity depends on the following critical criteria.

• The logic must understand the business calculation being modeled and must be created without errors

• The original logic must not be corrupted by subsequent users – with data inputs or maintenance activity, manual or automatic

• Version controls must ensure tasks and amendments are executed on the spreadsheet in the correct order by multiple users

Quite a few organizations have moved to adopt technological solutions to reduce spreadsheet risks and facilitate compliance – they range from manual to automated options. While manual solutions may be somewhat effective, they will always suffer from an inability to monitor all spreadsheet rows, columns, and sheets within a reasonable period of time. Plus, they do not guarantee spreadsheet integrity in each subsequent user interaction. Regulators therefore mandate that manual controls be tested repeatedly, unlike automatic controls.

An effective web-based solution that focuses on change management and user interaction will allow business to monitor and expose variant information at all times and for all changes without disruption to business. Plugging in appropriate controls (relating to version, change, access, security, back-up and archiving) will provide reassuring and compliant transparency on data usage, ownership, confidentiality, availability and escalation procedures.

With end use computing promising to remain a fundamental part of business operations, especially for management information and regulatory reporting, such an application should improve and protect integrity of spreadsheet data and calculation without changing the individual’s user experience or adding complexity to IT environments. The following key questions need to be asked of such web based applications

1. Will it use secure web services to connect the spreadsheet clients to data warehouses or LOB applications that already exist in the organization for real time query of centrally controlled information?

2. Will it maintain version control?

3. Will it manage and track user access to data and business logic in a transparent manner?

4. Will it provide the reassurance of transparency on data usage, ownership, confidentiality, availability and escalation procedures?

The A of C.A.R.E - Assurance Three fundamentals of an efficient financial modeling are controls, usability, and functional improvements. These three fundamentals can be further broken down into the following features

• Access control and security

• Version control

• Data storage / control

• Workflow

• Transparency

• User experience

• Back-up functionality

An efficient web based application will eliminate error-prone manual processes of extracting data and computation definitions. It will enable seamless exchange of information over a secure network by calling for and pulling information from the enterprise’s database into a spreadsheet ‘look-and-feel’ web tool. This will eliminate the need for manual input of data and creation of multiple standalone copies of enterprise data.

Security will not be compromised. Centralized version controls can prevent simultaneous existence of multiple versions of workbooks. A strong authentication system can restrict users to the appropriate information and servers, based on their roles. Business logic may similarly be controlled for access, thus minimizing risk of incorrect formulas and unintended changes.

The web service may also be designed to allow authorized users to make changes to both data and logic in the central database so that updates are transparent, real time and available to users. This enables business intelligence to deploy financial analyses and reflect them immediately in management reports and dashboards.

The assurance of such streamlined processes in a well-controlled environment are multifold.

• Data transfer and copy errors are eliminated. Result? Accurate data used in financial analyses for critical business decisions

• Analysts continue to work in a familiar spreadsheet environment they are well versed with Result? No additional training or cumbersome changes to work processes. Greater buy-in to move to a safer environment

• Speed access to the most current data. Result? Agility of decisions leading to greater productivity

• Ability to maintain audit logs for compliance to regulatory requirements. Result? Transparency of reports to stakeholders, auditors and regulators

• Easy administration of changes in one central location and applied to end user clients. Result? Eliminate cost inefficiencies and risks of creating multiple versions of data and business logic. Higher savings and returns on investment

The R of C.A.R.E – Return on Investment

The fact that over 90% of errors go completely unseen and undetected does not allow for evaluating ROI on the basis of what did not happen. Even so, a web-based application for spreadsheet management and controls can provide attractive returns on investment in several ways.

First, its efficient administrative control function will make it easier for auditors (both internal and regulatory) to evaluate the control environment, validate calculations, and opine on business processes built around the use of spreadsheets.

Second, the improved controls and alert systems in web applications will reduce investigation time when things do go wrong. It will allow a problem to be identified earlier and resolved sooner, thus reducing cost of investigation.

More sophisticated spreadsheet control technologies can be made possible in web-based applications. These allow for real-time collaboration between spreadsheet users, and improved business processes for issues to be addressed in the daily workflow instead of going through lengthy e-mail exchanges or meetings.

Finally, the relief of maintaining unwieldy spreadsheets and the consequent loads on email servers is a huge advantage that can be quantifiably equated to cost efficiencies.

The E of C.A.R.E – Efficient processes

For the CFOs, CIOs and CROs, the effects of recent financial developments are staggering, and their challenges grow day by day. For instance,

• The need for more creative deal structuring to leverage newer market opportunities

• The challenges of increasing alternatives to consider with multiple stakeholders

• The complexity of regulatory environments and auditing requirements

• The burgeoning operations risks and limited organizational resources

The key business drivers that need to be addressed are

1. Custom executive views

2. Enhanced time-to-market

3. Scalability and business agility

4. Workflow automation

5. Just-in-time reporting

6. Productivity improvement

7. Enhanced governance

8. Dynamic regulatory requirements

An effective web based application understands evolving business drivers and uses technology as an enabler to achieve efficient mirroring of processes that is key to financial modeling.

Such processes achieve the following

Understanding of assets and transaction to gather data Relationship between key variables, assumptions, deal participants, alternatives, etc

Describing of key relationships through the model Flexibility to accommodate the dynamic nature of relationships

Creating insights rather than numbers Sensitivity and scenario analysis, dynamics between key performance factors and assumptions

Communicate results Reports, dashboards, recommendations, etc

Create library for reuse Document model logic and key assumptions

The advantages and benefits are obvious – improved modeling speed, quality of analyses and focus shift from data manipulation to decision making for better return on investments.

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Since their advent nearly five decades ago, electronic spreadsheets have enabled businesses to enhance the quality of their decision-making processes. They have provided analysts with astute insights into market events and the consequences associated with their decisions. However, the evolution of spreadsheets has also come at the cost of exposure to an increasingly urgent set of risks and issues.

To effectively address today’s financial analysis requirements, an entirely new modeling metaphor is needed. A web-based model will push model structuring and navigation beyond the limits of traditional spreadsheets. By formalizing artifacts (deal participants, financial instruments, and timescales) and transactions, this modeling approach will speed up analysis, simplify and improve communication among all involved stakeholders and reduce risk of errors and fraud.

We believe that organizations that adopt a web-based application model will retain a long-term competitive advantage through accurate and speedy insights and confident decision-making. The four critical features of such an application (Compliance, Assurance, Return on Investment and Effective processes) will provide business enterprises an intuitive modeling approach for differentiated capabilities to manage regulatory changes, diverse investor objectives and emerging product areas.

CONCLUSION

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