As professional accountants, or as consultants or as internal auditors, when we receive any enquiry for an assignment, to know about the organization and to assess the possible scope of an assignment, we prepare a Diagnostic Review Report (DRR). Information we seek largely depends on the objectives for the requirement, while some content is common to all assignments. I am sharing my thoughts on what information we could seek and what could be the possible content in a DRR, in this article.
1. Business Overview:
Client’s business related details like Industry, whether in to Services or Goods, Financial Services, IT or ITES, Manufacture of Goods, Selling, Distribution; legal status, whether Proprietary, Unlisted or Listed Company, Holding or Subsidiary Company, activity level in terms of annual turnover, number of employees, number of offices or places of business, whether has any overseas operations and any other information that brings into context, objectives of the DRR, like past growth, constraints, opportunities and future growth potential. Sources of information are details as explained by the stakeholders from the client, literature provided by them, their website of from any public domain.
For undertaking a DRR, Objectives could be any one or more of the following:
i. Achieving improvements in Profitability, growth, Cost Reduction or others for better economic performance.
ii. Eliminating a pain area or a problem or a collection of problems.
iii. Strengthening Internal Controls under the 5 “P”s, namely Policies, Procedures, Processes, Practices and People.
iv. Meeting Compliance requirements.
v. Achieving Operational efficiencies though automation.
vi. Any other.
3. Information Requirements– General:
Based on the Objectives chosen, information needs will be identified. However, basic info needs, independent of the Objectives are the following:
i. Functions: Important functions of the organization, like Marketing, Manufacturing Operations, Storage & Distribution, HR, F&A, Logistics and Administration could be identified. Organization Chart showing details of manning, reporting relationships, important decisions for running the organization and who takes them, as well as important processes with which these functions are associated could be listed.
ii. Financial Reporting Processes:
Reliable financial information, generated through basic book keeping and robust financial reporting process is essential for relying on any information obtained from reporting. It is necessary to closely review method of recording transactions, processing and reporting. Enquiry on which computerized application is in use, whether packaged software or custom made, and a quick walkthrough of the reporting processes, picking up a couple of samples, to form an opinion, whether the information is reliable, is adequate.
iii. Process Documentation:
One could refer to any documentation available in the organization. Otherwise, Processes could be reviewed under 3 categories, namely:
- Order to Collection
- Purchase to Pay and
- Support Processes in HR, Admin, IT and Finance.
Methodology: In the absence of documentation, information could be gathered and recorded as Activity Description:
- Under each process, activities performed in a sequence
- Documents used for recording such activities and
- Information flow.
Having gathered information required in general, we can move towards specific objectives.
4. Information Requirements – Specific Objectives.
i. Achieving improvements in Profitability, growth, Cost Reduction or others for better economic performance: Authentic Financials provide basic information. Financials (P&L and Balance Sheet) over a period of time should be analyzed, first by visual inspection of big numbers (negative or positive) like high receivables, inventory, high direct material consumption, Investments or accumulated Reserves, Profit track record and so on. Choosing suitable Accounting Ratios pertaining to P&L, Balance Sheet or between P&L and Balance Sheet like Return on Capital Employed, we could identify strengths or areas requiring improvement. Contribution per limiting factor, will help in identifying profitability trends at higher levels of activity.
Investment in Fixed Assets & Establishment, extent of Capacity Utilization, and review of opportunities for growth in the market, as well as further investments required for expansion, help in projecting profitable growth.
Working Capital Reviews as well as inefficiencies thrown up in Ratio Analysis, compared with Industry trends / norms, can help in identifying processes requiring improvements.
ii. Eliminating a pain area or a problem or a collection of problems: Financial information gathered can be corroborated with problem / pain areas, and coupled with close review of relevant process reviews and root-cause analysis can lead to actions required to eliminate pain areas.
iii. Strengthening Internal Controls under the 5 “P”s, namely Policies, Procedures, Processes, Practices and People: Process documentation, relating key Processes to Policies, Procedures, Organization Chart, Management Reports, availability of authentic data and organized information processing methodologies helps in identifying opportunities for strengthening controls. Policies should address important Business Objectives. Procedures should support Policy Implementation. Clarity on Org. Structure, reporting relationships and roles help in decision making at right levels.
iv. Meeting Compliance requirements: Identifying provisions and enactments relating to direct & indirect taxes, and other statutory compliances should be compared with actual compliance to see whether such requirements are met. Identification of transactions which are subject to compliance requirements, and related processes help in assessing the actual situation. (This section could be elaborated to cover specific direct, indirect taxes and other compliances).
v. Achieving Operational efficiencies though automation: Generally upgrading information systems, say from Tally to ERP fall in this category. After identifying what prompted such an upgrade, whether increase in scale or elimination of problems, proper requirement analysis, identification of technically suitable application, detailed project plan for implementation, identification of an active involvement of key stakeholders, will help in assessing feasibility of such a systems upgrade.
5. Interim Report:
Since time at our disposal is usually limited, for conducting a DRR, based on materiality, information requirements should be confined to essentials. Major findings, in the form of observations, could be shared with the client for validation, before finalizing the report.
6. Final Report:
Stating the Objectives, and referring to the Client’s LOE for DRR, findings and recommendations could be stated in the Final Report. Based on complexity, we could have an Executive Summary and a Detailed Report, where required.
An effective DRR, which properly highlights key issues with possible options for exploring solutions, more often than not, ends up in bagging the assignment.
For more articles from me, please read my book, “Translating Operations into Money – Cases in Business Management”, available for online purchase through Amazon.in or Flipkart. You could also visit www.operationstomoney.com.
Thank you for your attention.