With the globalization of businesses has come the widening of supply chains and a significant increase in the number of partners a business works with to manage growing volumes. All of this has changed the complexity of the commercial transactions executed by the business manifold. Accounting, reconciliation, and settlements have thus become challenging and time-consuming affairs. Auditors, tasked by the business stakeholders to ensure that the financial statements prepared on the basis of the company’s accounts are correct, backed by a proper trail of documentation and comply with the legal, regulatory and accounting GAAP boundaries, are inundated with huge volumes of data. Despite technological advances, it is not possible for them, at any one point in time, to guarantee the veracity of all the accounts.
Blockchain, the technology underlying cryptocurrencies like Bitcoin, on the other hand, is known as a tamper-proof, distributed ledger that is shared across organizational boundaries, protected in a layer of cryptographic security. In private blockchains that are managed by a specific business entity or consortium, transactions are added as ‘blocks’ to the shared ledger, are made available to all parties on the blockchain at the same time, and are immutable. Trust is built into blockchain through the validation mechanism, wherein each transaction is validated by designated ‘transaction validators’. The transactions are executed in accordance with ‘smart contracts’, further building trust in the validity of the entered data.
All of these are pretty revolutionary features, and manage to overcome organizational boundaries in data sharing, transparency, and trust. Supply chain, payments, land and property records, and insurance claims are today often spoken about as classic use cases for the application of blockchain technology in the business context and are seeing heavy investments by companies exploring the potential benefits.
How can blockchain lead to a paradigm shift in F&A?
Today, for a single sale transaction, the buyer records the transaction in their system/ERP. This is repeated by the seller in their internal system/ERP, and the process is repeated for every accountable event in the transaction flow. Auditors audit the financial statements produced by these accounting events.
Let us consider a simple example: Company A sells goods to company B worth $ 10,000. This involves (at the very least):
- Recording sales order in books of A and purchase order in books of B
- Recording outward shipment of goods in books of A and
inward receipt of goods in books of B.
- Recording customer invoices in books of A and recording vendor invoice in books of B.
- Recording outflow payment in books of B and inflow payment in books of A.
All the above transactions are backed by documentation, as well as approval, inspection and validation workflows. Today, transactions are recorded and updated separately by company A and company B as the transaction flows through several stages. To know the real status of the transaction, follow-ups are required, usually through calls or emails or other channels. At every step of the transaction, accounting entries are updated in each company’s books of accounts. Auditors ascertain that the transactions are legit by scrutinizing the underlying documents and verifying the status with the other company.
With the use of blockchain technology in supply chain, payments and logistics functions, transactions will be simultaneously added and validated in the single distributed ledger. Everyone will have visibility into the current state of the transaction, with shared relevant documentation. Since the transactions are already validated by appropriate parties, auditors can place their trust in the legitimacy of those transactions. Furthermore, any modification to the transaction is recorded and has to be validated by the validators.
The Paradigm Shift
Our example is a very basic buy-and-sell transaction between two parties – real world deals are infinitely more complicated and involve more than just two parties. For example, the above transaction would also involve the logistics company, the customs departments for cross-border movements, warehousing company, insurance companies and so on.
Blockchain technology can enable significant productivity gains for F&A function in the following ways:
- Transactions need to be recorded only once in the blockchain across all involved parties. This significantly reduces data mismatches and reconciliation effort.
- Contracts binding parties to transactions are encoded and shared, introducing transparency and reducing disputes.
- The F&A department can get all the required details online for all purposes of accounting backed by validated transactions and documentation.
- Transactions verified on blockchain are immutable. This enables auditors to perform continuous auditing with a degree of certainty.
Most importantly, blockchain opens up huge automation opportunities and can bring a paradigm shift in the way F&A processes are run today. One may argue that the technology is yet at a nascent stage, or that it needs many parties onboarding the blockchain to be effective, but I think the process has started and sooner or later it will evolve to the desired state and maybe beyond.