Cost Recovery

Turning Your Accounts Payable Department into a Profit Center

Richard B. Lanza

• Publisher: Wiley
• Year: 2009
• ISBN:
  9780470526149
• Edition: 1
• Topic: Business
• Subtopic: Managerial Accounting
• Index: Business

• Cost Recovery: Turning Your Accounts Payable Department into a Profit Center shows how to identify a company's hidden financial assets.
• It provides tools to assist organizations generate cash recoveries, stop profit leaks, move away from control issues, and work towards process improvements.
• The book shows how to incorporate profit recovery technology, and how to pair a company with a recovery expert best suited to the company's needs to achieve bottom line results.
• The book discusses how to utilize free services offered by cost recovery consultants, using of top money-saving proves improvements, and how to create a plan to maximize recovering technology.

CHAPTER 1

Benefits of Recovery Services

U.S.General Accounting Office Report¹ “Recommends” Recovery Auditing

Like many private sector business leaders, circumstances in 1996 dictated that the Secretary of Defense evaluate the possibility of using a recovery audit firm to uncover overpayments made by the Department of Defense (DOD) to their vendors. When the final results were in, the United States General Accounting Office (GAO) issued its assessment of the completed process. The results were instructive. (For the full report from the GAO, please visit http://gao.gov/archive/1999/ns99012.pdf.)

The effort began in September 1996, and the recovery audit covered purchases made during fiscal years 1993 to 1995. In late 1997, Congress authorized expansion of the program, and in an August 1998 memorandum, the DOD Comptroller encouraged DOD agencies “to use recovery auditing as a way to identify and correct payment problems.”

The methods used resulted in the detection of $19.1 million in overpayments—about the cost of four new M1-A2 Abrams Main Battle Tanks at the time.² Efforts to identify additional amounts continue. Of the $19.1 million in overpayments, $12.4 million was due to cash discounts not taken or deducted at the wrong rate, $2.2 million was related to most favored customer terms not received, $1.3 million was due to duplicate payments, and $1.2 million related to credits not taken.

The fact that the overpayments were made four to six years before the audit recovery began made overpayment identification or recovery challenging. This was yet another example of “get it early or it’s gone,” which is word to the wise for anyone looking to recover lost profits. Another hurdle encountered by the recovery firm was when it realized that the DOD payment system did not retain all of the information needed for analysis. In some instances, the firm found that it had to manually sort through records. So another lesson for the private sector is to make sure your computer system stores all necessary and critical information.

In addition to identifying overpayments, the recovery firm also recommended methods outside the scope of its contract to reduce future overpayments. This is not unusual and another reason why recovery audits pay off. The DOD concurred with the recommendations made by the recovery firm and then worked to implement them to reduce and eliminate future overpayments.

While the GAO report did not suggest any definitions, what follows are two key concepts that will be defined here for future reference in this publication:

• Cost recovery. Cost savings that are either retrospective or prospective in nature and result from the detection of internal or external errors and fraud; industry benchmarking; previously unknown tax advantages; contractual analysis; and contractual or price sheet compliance.

• Recovery audit. The methodical process of reviewing disbursement transactions and related supporting data to identify various opportunities for cost recovery and that often suggest new process improvements and technology to ensure such cost recoveries are minimized or eliminated in the future.

Top Benefits of Cost Recovery

The aforementioned GAO report was an extensive analysis of a cost recovery engagement and from it some simple truths can be inferred. In its essence, the service found cash that the DOD never knew it was missing and it obtained process improvements to ensure that such cash is never overpaid again.

These two simple truths are explored further here:

• Every process flow has a margin of error. In a process flow of $100 million, a 0.1 percent margin of error (that is, 0.001) translates into $100,000 in recoveries. This statistic is used frequently for accounts payable audits, and while never fully validated, it is a reasonable starting point. Essentially, the process flow in this example is 99.9 percent accurate. Other recovery services find much more in percentage form but may look at a smaller area of spend, such as the advertising expense of a company.

• Incur costs only after getting paid. Companies generally will only pay a recovery firm if the company deposits cash into their bank account as a recovery. The practice is so productive, and the effect on the bottom line so substantial, that many corporations hire more than one recovery auditing firm to analyze the same data. That is in addition to companies’ own auditors, who usually find the most obvious errors. Recovered overpayments are found money and add directly to a company’s bottom line, except for the percentage paid to the recovery auditor.

• Measure the need for improvements. Rather than identifying vague concerns within a business process, a recovery audit finds quantified cash leakages within the process. These are deposited at the company’s bank. Then, depending on their materiality, allow the company’s management to assess whether it will work to improve its operations. Some companies never improve their operations and view recovery audits as a safety net that will collect the error rate in the process. This approach is more detective in nature but is a valid approach, especially if the error rate at the company is found to be relatively low.

• Provide the company an opportunity to learn from outsiders as to industry best practices. Such best practices come in the areas of process, technology, and people skills based on the auditors’ experience in various other similar companies. Systems (and the demands made on them) are growing as payment departments are shrinking. Companies merge, change systems, outsource, and have employee turnover. All of these scenarios contribute to potential lost profits and, therefore, best practices are needed just to keep pace with the rate of change. When best practices are applied to processes, any benefits received can be for current procured activity but can also apply to future activity and, hence, future savings.

• Improve Sarbanes-Oxley compliance. As is discussed in more depth later in this chapter, another more recent motivation for conducting a recovery audit is to help comply with Sarbanes-Oxley. A recovery audit covers much of the same ground a CFO must cover to ensure the integrity of a business, from process controls to contract compliance to payment checks and balances. An asset recovery audit firm will normally provide detailed reports on the financial health and well-being of your payments process and contract compliance. You may think of a recovery audit as an extension of your existing audit strategy. In all likelihood, however, the return on your recovery audit investment will exceed that of other similar pursuits.

• Add free resources to the audit team. Audit teams can be supplemented by additional staff of recovery auditors who are paid only if they add to the company’s bottom line. It is almost a best-case scenario for hiring employees, and recovery firms are more than willing to oblige.

• Add profits by not increasing sales. Most companies work under the model that if they can just increase sales, their net profits will increase. As an alternative to increasing sales, however, recovery audits have distinct benefits, since recovering $1 million to the pretax bottom line can equate to $10 million in sales at a company. Nonsales departments are engaged and increases in fixed overhead and working capital required for more sales are avoided. Lastly, it is not uncommon in some businesses that the more they increase sales, the more they lose money. While it sounds impossible, some companies will sign up for sales price arrangements whereby every additional unit costs them more than they can sell it for and, hence, they lose more for every unit. Recovering costs will never have this effect.

• Create an air of transparency between your company and your vendors. The recovery auditor may find nothing. But even then, the company still knows more definitively that there are not any cash leakages being held by vendors.

• Get it before it disappears. As profit recoveries are time sensitive, the longer an organization waits, the more difficult it is to identify, validate, and retrieve them. A no-risk contingency-based audit is the most cost-and time-effective way to recoup your lost dollars. Lastly, there is no downside with contingency engagements as, say, $0.70 after recovery fees for every $1 recovered a company never knew it had is better than nothing.

Recovery to most companies is a no-brainer decision. While all audit areas may not be material enough to make a review fruitful, even the smallest of spend could benefit from applied recovery audit techniques.

Top Reasons for Recovery

At this time, it may be useful to see how such recoveries are found so that the potential can be visualized. There are five broad activities that can be considered under the heading of recovery auditing.

• Internal error and fraud. These are recoveries that are due to an internal mistake in processing a payment or an employee who has a conflict of interest with a vendor.

• External error and fraud. Such recoveries are due to vendor mistakes or an attempt to defraud an organization, which may take the form of purposefully sent duplicate invoices.

• Industry benchmarking and tax advantages. Experts who understand the marketplace or the tax code can apply this knowledge to organizations that were previously ignorant of such information. With this new information, they can make better business decisions, which can lead to previous and future savings.

• Contractual analysis. Similar to industry benchmarking, contracts can be reviewed by experts to assess any unfair provisions that, when modified, lead to a more profitable agreement with the vendor.

• Contractual and price sheet compliance. Writing the best contract in the world does no one any good unless it is followed and vendors are held to key provisions. By reviewing these contracts and making sure vendors are living by them, companies can recover lost funds. The company can also do a self-audit of its organization by making sure it is using preferred pricing when available. For example, many companies will sign group purchasing contracts with office supply vendors and then never buy under those contracts because it is easier to simply walk down to the local supply store. This internal compliance can also be monitored by recovery firms to everyone’s benefit.

Recovery Estimates—Embrace the Uncertainty

For a number of reasons, some laudable and some not, modern corporations seek to eliminate uncertainty before making even the smallest commitment. For this reason, nearly every recovery audit being considered faces questions about its likely outcome. Unfortunately, many promising audits are never pursued because it is too difficult to estimate recovery levels for most specific recovery areas. This is due to the following reasons, although this list is not extensive nor is it in any particular order:

• Willingness of the company to support the recovery firm

• Company’s changes in technology

• Company’s staff experience and knowledge

• Extensiveness of the audit

• Volume of transactions

• Value of transactions

• Vendor(s) selected for the area of spend under review

Many accounts payable audit firms have quoted a 0.1 percent recovery rate. While this sounds reasonable, there is generally no basis for the number, and the types of recoveries found can vary widely between companies. Some accounts payable audits may find duplicate payments while others detect pricing discrepancies, so it is difficult to assess the level of potential recovery. Some audits can have recovery rates that exceed 40 percent of the client spend, although this is in an extreme case.

Given the difficulty in estimating recovery, some firms will analyze the client situation to assess potential which may be by:

• Reviewing building leases

• Running duplicate payment reports to see how many exist in the client files

• Reviewing advertising agency contracts

• Running health care medical claim payment data to understand the nature, types of procedures, and providers with high spend

Suffice to say, some standards have developed over time, yet it is too difficult to predict the expected savings at a company. This should never be a concern as any recoveries found, regardless of the size, puts companies in a better position than before starting the audit.

When Recovery Becomes Fraud³

Recovery audits routi...

Table of contents

• Praise
• Title Page
• Copyright Page
• About the Author
• Foreword
• Preface
• Acknowledgements
• How to Use This Book
• CHAPTER 1 - Benefits of Recovery Services
• CHAPTER 2 - Overcoming Obstacles to Getting Recovery Started
• CHAPTER 3 - Assessing Opportunities and Risk
• CHAPTER 4 - The Overall Cost Recovery Marketplace
• CHAPTER 5 - Accounts Payable and Procurement
• CHAPTER 6 - Advertising Agency Audits and Media Reviews
• CHAPTER 7 - Audit Firm Benchmarking
• CHAPTER 8
• CHAPTER 9 - Freight Bill Auditing
• CHAPTER 10 - Health Benefits Auditing
• CHAPTER 11 - Lease Audits
• CHAPTER 12 - Order to Cash Reviews
• CHAPTER 13 - Payroll Tax Credits
• CHAPTER 14 - Proactive Fraud Audits
• CHAPTER 15 - Project Fraud Audits
• CHAPTER 16 - Real Estate Cost Segregation
• CHAPTER 17 - Research and Development Tax Credits
• CHAPTER 18 - Strategic Sourcing
• CHAPTER 19 - Telecommunications Auditing
• CHAPTER 20 - Travel and Entertainment Reviews
• CHAPTER 21 - Utility Reviews
• CHAPTER 22 - Selecting a Provider
• CHAPTER 23 - Technology Used in Recovery Efforts
• CHAPTER 24 - Conclusion
• Appendix 1 - Additional Publications Related to Business Cost Savings
• Appendix 2 - Accounts Payable
• Appendix 3 - Records Retention and Right to Audit
• Appendix 4 - Discussion Paper Continuous Controls Monitoring with ACL ...
• Appendix 5 - Tapping the Strategic Potential of Procurement
• Index