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Open and hone st accounting

BRIEFINGS

Open-book accounting is being adopted more and more frequently in today's construction industry. It is a common feature of partnering agreements, adopted in a deliberate attempt to reject the traditionally adversarial structure of the industry.

However, despite its increased use, a great deal of mystery surrounds the use of open-book accounting and little practical advice exists. In this Briefing, we explain how to unravel the mystery and adopt a simple strategy for implementing open-book accounting

Be aware of the potential pitfalls

Open-book accounting is usually a sign of mutual trust between client and supplier, but it is not without its potential difficulties. Whenever you agree to adopt open-book agreements, be aware that:

Clients often ask for too much information.

Client audits can be disruptive.

Contractors may not have adequate procedures in place.

Relations can revert back to adversarial stereotypes when problems occur.

Blame culture can set in, leading to: immediate mistrust; the teamwork and cooperation disappearing.

Don't rush into things

It is impossible to say how long it will take to set up a workable open-book accounting system. It depends on the complexity of the project and type of contractual relationship. But by using a consultant with implementation experience the management time and expense can be greatly reduced. It can also help to develop the right cultural approach.

Finger on the pulse

The final ingredient to successful open-book accounting is one of constant review. Review the audit strategy on a monthly basis, perhaps moving to quarterly reviews once the system is proven, and repeatedly ask yourselves two fundamental questions: Does the strategy enable the contractor to be paid correctly and comply with the client's corporate governance? And does the strategy provide useful management information?

If you have to answer 'no' to either of these questions, changes will need to be made.

Six steps to solve the open-book mystery

The key to success is to spend time up front. Try these six steps before the first application and before the first costs have been incurred:

1. Agree definition of actual cost

This seems straightforward but is rarely carried out in practice. Review each of the definitions (by resource) and work through practical examples. This will be time well spent as any misunderstanding here may lead to the wrong processes being set up.

2. Understand contractors' cost systems

This involves charting and mapping how the costs are recorded and is often best carried out on site. It needs to be carried out in detail to ensure it is well understood. The costing structure or hierarchy - how costs are broken down on each scheme - will also be explored 3. Understand contractors' existing accounting procedures How is subcontract work valued and paid? How are credits allocated?

What happens if materials are overordered? How is the uplift calculated on payroll costs to take account of National Insurance and pension contributions? This can be a complex stage in the process and is best reviewed by commercial and finance staff from both organisations working together. This is particularly relevant when exploring issues such as how national rebates with suppliers are allocated. It is also important to understand how the supply chain is constructed and whether internal company transfers enable a group of companies to obtain overhead on overhead and profit on profit.

4. How will the definition of cost be complied with?

Having understood the definition of cost, see how the contractor's accounting system can be altered so that it complies with the contract.

Ideally the contractor will have already addressed this but if not, work together - come up with a quick fix then develop a longer-term solution if appropriate. For example, maintenance costs on vehicles may need to be allocated differently if the client is paying 'all in' hire rates.

5. Agree audit strategy

This is crucial - there is nothing worse than disruptive audits.

Develop an audit matrix that clearly spells out who/what/where/when/ why and how. Include resource requirements and contact details.

This will enable the contractor to respond to requests for information and save a great deal of time and effort in the long run. The client may wish to leave some audits to be conducted on a random basis - this is fine but should amount to no more than perhaps 10 per cent of the audit strategy.

6. Dummy run

By this stage all the procedures should be in place. However, despite all the effort and groundwork, problems may still occur. By carrying out a dummy run these can be ironed out and dealt with before becoming critical. This is as much about people working together effectively as testing the procedures themselves. Close this stage out with a review of stages 1-5 and implement any changes that are required.

Cash flow benefits for the contractor

If set up correctly, open-book accounting can provide the client with a detailed understanding of its cost base and, in return for its openness, an improved cash flow for the contractor.

Both can also enjoy greater cost certainty and potential for gain share. In summary, the benefits include:

Greater cost certainty.

Clients can better understand their cost base.

Allows benchmarking of cost and productivity.

Helps to establish cost saving strategies and eliminate waste.

Improves cash flow.

Potential incentive arrangements.

Focuses management effort to drive down cost.

Audits tailored to suit situation

The audit approach may need to be tailored to the type of work.

For example, Stephen Leathley, head of finance at NHS Estates, is in the process of developing a central audit strategy for ProCure 21 (the NHS capital procurement programme).

He says: 'With perhaps up to 12 framework contractors in place and a workload of approximately £1.4 billion per annum across some 500 sites, it would be inefficient to individually audit every scheme.

'We intend to carry out central and consistent audits of each of the framework contractors and their supply chains alongside compliance checks out on site.'

For further information

A series of one-day workshops on the principles and practice of open-book accounting have been organised by Knowles Management for mid-May.

These are aimed at both clients and contracting organisations and will help participants to develop practical techniques to successfully adopt an openbook approach. For more information contact Louise Downs by email at louise.downs@jrknowles. com or by telephone on 0114 273 8878

About the author

Dr Stuart Kings is a regional director at Knowles Management and has responsibility for implementing open-book accounting strategies in organisations. You can contact him on 0114 273 8878 or e-mail: stuart. kings @jrknowles. com