By Jim Burke, senior VP of contracting and pricing solutions, Alliance Life Sciences Consulting Group
Financial accruals have become a major headache for corporate finance teams in the life sciences industry as they are increasingly difficult to manage and can lead to major business issues if calculated incorrectly. These accruals are an important part of compliance with generally accepted accounting principles (GAAP). Funds are set aside to cover the financial obligations associated with sales and from promotional programs, rebates, and discounts. They are hard to manage due to the fact that the data for each type of program is captured in different places within an organization. The data associated with co-pay programs, direct rebates, and chargebacks must be gathered, and then the amounts to set aside must be determined based on past and future projections.
The problem is that most companies don’t have an automated way of pulling all the data together and calculating the appropriate accrual rate. Manufacturers do the calculations manually or in an offline tool. Depending on the company and the kinds of promotional programs it offers, calculations can range from the complex to the extremely complex.
Any calculation errors can have a significant impact. If the accrual percentage is too high for rebates and promotions, funds are essentially being taken away from other areas of the business, such as research and product development, which can help grow revenue. But if enough isn’t reserved, manufacturers could find themselves in a cash crunch, and money will need to be borrowed to cover obligations. If the amounts get too large, it can also be considered a “material impact” item for earnings reports.
There’s another aspect that companies are missing. Many organizations are spending more time and money on the mechanics of the accruals — the number crunching — than on understanding what the data is telling them. They’re missing an opportunity to analyze the accruals to see what promotions and programs are really driving the business, helping them expand market share, and affecting revenue.
AUTOMATING THE ACCRUALS PROCESS
Most companies have a consistent set of issues to address. Compliance is first and foremost on everyone’s mind. The accrual methodology has to align with GAAP, and then ultimately, a system should be in place that has the right process controls and audit capabilities. The methodology must be documented, i.e., how you came up with your calculations, and it must be reconcilable to your auditors. But the formula can’t be static or locked down. The accrual rates need to evolve over time based on actual business results and sometimes may need to adjust to the rates in real time, so the process has to be flexible enough to accommodate human intervention.
The calculations may need to be adjusted when unforeseen events occur — shortages, business interruptions, and other unplanned circumstances. An example from the generics pharmaceutical world: Imagine that you are one of only three companies producing a certain compound. You learn that the FDA has shut down one of your competitor’s plants, so you know that your sales are going to increase. If you have volumedependent pricing or rebate programs that incorporate that product, you will need to increase your accrual rate to accommodate higher sales projections. It’s an unpredicted circumstance, but you have to deal with it immediately.
KEY CONSIDERATIONS & RECOMMENDATIONS
Some of the key success factors are to consolidate the incentive program data into a central system, to apply systematic accrual rate calculations, and to evolve them based on real results over time. Depending on the situation, it might not be possible to automate 100 percent of the transactions, but it can still be valuable to automate as many as possible, while allowing the flexibility for human intervention when needed as a means of controlling the process without constraining it.
Finally, one shouldn’t simply focus on getting the calculations right. Analyze the data to see which promotional programs are having the greatest impact on the results. Fine tune the mix of programs so that results are being continually optimized.