Monitoring Financial Condition
- Posted by David Gray
- On October 21, 2020
It’s not unusual for boards which have not previously worked with the Policy Governance® model to respond very positively when it is explained to them and to express enthusiasm for implementing the model.
However, it’s also not unusual for boards new to the model to stumble when it comes to using limitation policies to monitor financial condition.
One of the most important concepts in Policy Governance is the need for a board to control all it must control, not all it could control. Nowhere is this concept more important than in the area of governing financial condition: making sure that the ongoing, day-to-day condition of the organisation remains within parameters set down by the board.
The traditional way for a board to address this responsibility is to require the CEO to present the organisation’s financial statements at regular intervals (say, monthly or quarterly). Board members are then encouraged to analyse the statements and form a view on their contents, which view is then shared with other board members in an effort to arrive at a consensus about whether or not the organisation’s financial condition is acceptable to the board.
Unfortunately, this process all too often goes pear-shaped.
Financial statements contain a vast array of financial information (much of which, let’s admit, the average board member doesn’t understand). If the board has not stated in advance what it will regard as acceptable financial condition, the CEO is often required to respond to random questions about the numbers, from the sublime (Why is revenue up by $5 million this year?) to the ridiculous (Why did we spend 17.32% more on biscuits last month?). The poor CEO has no idea what the board is really looking for and, therefore, no idea how to present better-quality and more targeted information to the board.
There’s a much better way of exercising financial governance, and we discover it by applying the principles of Policy Governance.
At the most basic level, the board’s job in relation to financial governance is—
- to spell out the difference to be made by the organisation and the limits that must be observed while the difference is being made;
- to delegate authority to the CEO to make the difference and to spell out the limits of this authority; and
- to make sure the difference is actually made and the limits are actually observed.
Importantly, the board doesn’t tell the CEO what to do; rather, it states what conditions it would find unacceptable and requires the CEO to avoid those conditions.
So, in relation to financial condition, the board spells out those financial conditions that it would find unacceptable—things like inadequate provision for meeting debts, inadequate controls on sensitive expenditure, any failure to comply with generally-accepted accounting principles and practices, and so on. By doing so, the board makes clear to the CEO what it will be looking for when it monitors the organisation’s financial condition, and the CEO is able to provide financial information which meets the board’s specific needs. The CEO is relieved of the pressure to flood the board with financial information in the hope that the answers to the board’s (unspoken) concerns will be found somewhere in the information.
One of the implications of this approach is that the board doesn’t have to see full financial statements every time it meets. Rather, it has to assure itself that the organisation is being managed within the prudential limits it has set down, at a frequency it deems appropriate.
Let me inject a note of practicality here. Some board members can’t get out of the habit of needing to see a full set of financial statements at every meeting. This is unfortunate, because the practice leads to board time being wasted on matters that do not pertain to the board’s Ends or Limitation policies. However, in recognition of the fact that such behaviour can be hard to turn around, I sometimes recommend a compromise, which is that full financial statements are distributed by the CEO as an information-only item in the board’s agenda. Information-only items are generally found at the end of the agenda and contain ‘nice to know’ (as opposed to ‘need to know’) information that the CEO chooses to bring to the board’s attention, but which are generally not discussed during the meeting. I have no objection to financial statements being included in this part of the agenda, provided there is no spontaneous discussion about them at the meeting. If a board member has a concern about anything in the statements, he or she should then follow the normal process for adding an item to the next board agenda. Boards that take this approach to governing financial condition suddenly find that the tension has gone out of the process. The board has made its expectations crystal clear. The CEO knows exactly where the boundaries lie and has maximum freedom to work within those boundaries. Provided the CEO is able to satisfy the board with data showing the board’s limitations are being observed, both parties are able to sleep at night without fearing confrontation at the next board meeting.