Reporting: Ready for open water?

PE Manager revisits some of the year's best guest articles: In November Michael Thompson, Greg Formato and Keith Chalfant of Ernst & Young provided some best practices for private equity executives learning to navigate new and updated reporting regimes.

Finance, operations and compliance executives at private equity firms are being held responsible for implementing historic reporting changes– similar to leaving the safe harbour of simpler reporting rules and setting sail for open water. To meet this challenge, private equity firms must modify their reporting process to work as a cohesive unit, a transformation requiring better coordination, communication and scheduling. 

Here are some leading practices used by successful firms:

• Define a formal reporting process and establish a calendar. Although many firms have formal documentation and policies, major changes like SEC registration require better organisation. The calendar must contain key milestones, such as closing the general ledger and submitting reporting forms to authorities. In addition to investor reporting and management reporting, firms have to prepare and deliver key financial data to the SEC to meet new requirements of Form PF. Finance departments must clearly communicate this and differentiate among the firm’s growing number of stakeholders.

• Identify and address bottlenecks. Delays are often caused by the late arrival of valuations, or new investment deals with non-routine tax-driven legal structures or a lengthy process of allocation. Firms can keep operations on track by managing these bottlenecks through their calendar. This enables management to identify critical issues earlier, while reducing the time needed for decision-making.

• Separate subjective tasks from routine ones. Production activities involving journal entries, account reconciliations and basic report formatting are different from analytical activities such as responding to limited partnership inquiries, flux analysis and what-if scenarios. When finance, operations and compliance professionals mix production and analytical activities, the time to shift between the two results in lost productivity.Today, many investors are requesting data that requires an unprecedented level of individualised attention. Firms that centralise routine tasks can generate time and cost benefits from scale, as reporting expands.

• Give the process its due — and expect to patch it from time to time. Private equity firms are continuously investing in new deal structures and investment products that may be unfamiliar to the finance group and can cause a conflict in the chart of accounts in the financial statement close. A last-minute, subsequent event that affects valuation can also create ripple effects to the fund financial statements — allocation of capital and ultimate consolidation —particularly if the accounting system is not fully integrated. Some of our more experienced clients find that by assigning a “captain” for thefinancial close, there is a way for the group as a whole to change its course in challenging moments or to track and make systemic repairs when everyone pulls back into port.

Open waters require the right technology: a wheelhouse with a rudder, an engine and a pump, rather than oars and a bucket. Until recently, firms have used basic spreadsheet applications and off-the-shelf private equity packages to navigate and stay afloat. But to prepare for SEC registration, more timely and effective financial reporting to investors and the next phases of ILPA guidelines, an integrated data enterprise system will become increasingly necessary.

Private equity firms will not be able to prepare for a greater level of reporting simply by adding more staff

One reason is account integrity: the more time spent tracking and posting economic and accounting events using Excel or other end-user computing, the greater the risk of error and backlog of work. Private equity companies with alternate portfolio strategies typically shift this effort onto investment accounting applications.

 In our 2010 Private Equity CFO Technology Survey, where we received feedback from approximately 40 private equity chief financial officers, firms reported that portfolio company financial data, valuation methodologies and capital account activity represent the areas of the most increased data requests.  An integrated data enterprise system can also improve a firm’s responsiveness to investors. Private equity firms must report information to a broad set of internal and external audiences. Many firms find that using reporting packages “on top of” their ledger and reporting technologies reduces the time to create customised reports and provides greater auditable control over the reporting process.

Private equity firms will not be able to prepare for a greater level of reporting simply by adding more staff. In fact, many finance, operations and compliance executives will be surprised to find that preparing for “open water” reporting will require them to change almost everything that they do. This will necessitate greater dependence on others to get things done on time as executives are held to a standard of quality that can make or break their careers – or, in some cases, can irreparably tarnish the reputation of the entire firm. With the stakes this high, private equity firms need the right team and the right tools in place – before they reach the open water.

Michael Thompson and Greg Formato are a partner and senior manager respectively at Ernst & Young’s New York office while Keith Chalfant is a partner at the firm’s Houston office.