Recovery audits, sometimes also referred to as profit recovery engagements or even profit discovery engagements (you have to love marketing’s unique spin), have existed for over 25 years. The purpose behind this practice is to identify and recover lost monies as a result of business process breakdowns.. These lost profits can be in the form of duplicate payments and other open credits such as overpayments, returned product, unapplied cash, etc. These engagements are usually performed on a contingency fee basis. This means the company pays the service provider a percentage of the lost monies recovered. If no money is found, the company does not pay any fees. Not bad.
While most companies will agree that performing an accounts payable recovery audit is a best practice, I am amazed at how many large companies ($1b and higher) I speak with that have not performed a recovery engagement within the past three years. While this is not based on a formal study, I would estimate that 1 out of 4 companies I have spoken with have not performed an audit in at least three years. I find this quite surprising. But what you may find even more surprising (or not) are some of the reasons.
Let’s start with the ‘Big Hearted A/P’ syndrome. This response is from an A/P Manager of a $1.5 billion company. “We feel a deep responsibility in partnering with our suppliers; it is a business culture that is important to us. As such, we feel that by collecting these lost profits we could put some of our suppliers out of business. We don’t want to put them that situation.” Keep in mind this is a public company. I was floored by this statement. Sure, there may be a strategic reason for not leaning on a certain vendor at a given time but this A/P Manager’s misplaced loyalty to all vendors all of the time is at a cost to the shareholders. It is 5 years later and, to my knowledge, this company has still not performed a recovery audit.
Next is the ‘But It’s My Fault!’ syndrome. We had been engaged by a different group within this $5 billion company to perform a special project. The project was a success and as a result we had valuable analysis, including duplicate payments, on the organization’s A/P operations that we decided to share with them. The Controller, Director of A/P, and A/P Manager were in the meeting with me. Upon learning of the duplicate payment issues, the A/P Manager stated he found it inconvenient and imposing on the supplier to collect the duplicate payments that they had made. He said he felt embarrassed for collecting the mistakes made by A/P from their suppliers. Pardon me? I truly could not believe what I was hearing. And the Controller agreed. This was a $5 billion manufacturing company at the time. It may not surprise you to learn that after the last market crash this company went into bankruptcy and it appears the banks will be taking it over.
Let’s look at these two reasons for not performing a recovery audit engagement. In my opinion, these organizations are neglecting their duties. This is money owed to their companies that they have an obligation to pursue. The ‘Big Hearted A/P’ example highlights a lack of understanding of A/P’s role as protector of its company’s cash, not banker to its suppliers. Unfortunately, some mindsets cannot be changed. The ‘But It’s My Fault’ position is not defensible either in my opinion. This A/P Manager has also failed to understand and accept A/P’s role as protector of its own company’s cash, not its suppliers. But this example has some elements which I feel are at the heart of resisting this best practice: fear.
For many A/P Managers and Directors, there is a fear of bringing problems to light within their own company or even externally to their suppliers. For some, it may be the concern that A/P resource is already strapped with its everyday responsibilities and will break with the addition of a recovery audit project. For others, there is embarrassment at the mistakes and concern that duplicate payments and lost profits identified through a recovery audit are a negative reflection on their performance and may put their job at risk.
Here’s an example of where the fear of the additional impact on resource can come back around and bite you. Many years ago, early on in my career, I worked with a team of great people who have also since moved on and are now at various companies. Many of the people are now Controllers or CFO’s. One individual, John, became Controller of a public company and is a friend of mine. As a friend, you would think he would purchase our solution easily. Well, the answer was no. One day I cornered John and asked him why he wouldn’t purchase our services. The answer was honest … “Karl, right now I am not aware of a problem in A/P and I know you, you’ll find business process breakdowns and I am sure you will save us money but I simply don’t have the bandwidth to deal with new problems”. Unfortunately for John, their external auditors did find problems two years later and he immediately brought us in. In the end he wished he had been proactive and identified and dealt with any problems before the external audit firm had identified them.
For management that fears any performance less than perfect will put their job at risk or be cause for embarrassment, my recommendation is to turn the potential embarrassment into power.
First, acknowledge that mistakes do happen in Accounts Payable. There is a reason this industry exists; your company is not the only company who makes mistakes. It is a fact that ANY Accounts Payable organization will process ONE mistake for every 1,000 – 5,000 invoices entered. Think about that … if you personally had to enter 5,000 invoices how many mistakes would you make? The error rate is probably smaller than you think. But if there are only 100 errors made in accounts payable and the average invoice size is $2,500 that is still a financial loss of $250,000.
Next, estimate what the error rate will be. There is a national metric used for error rates in accounts payable. It states that A/P processes invoices correctly 99.9% of the time. Therefore if you take the entire amount of your spend processed in A/P and multiply that number times .1% , you should understand your “expected” national average loss. I personally am not sure where the 99.9% metric originated from, but it has been around for a long time and appears to be widely accepted. Set that lost profit recovery expectation with your boss or even yourself. Then see where the audit actually comes in. Nowadays I find that most companies recoveries are below that generally accepted national average as more organizations have automated processes which produce fewer errors. Your department’s level of automation will play a role in your results.
After the engagement is performed you can see how your organization measured in relation to the expected amount. This will provide you with a sense of assurance that your processes are working as they should. So there is no need to be embarrassed or concerned.
I believe that every company should perform a recovery audit. I know this may seem self-serving because we perform those engagements, but I truly believe in the value that recovery audits provide and A/P’s obligation to protect the company’s cash. Internal and external audit focus on controls and valuation of A/P at a particular time. A recovery auditor’s goal is very different. It is to simply identify your lost profits and recover them for you.
What are your thoughts? I’m interested in hearing.
Thanks for reading!