How do we transform finance to cope with constant change? One word; Collaboration!

From Steve Player, North America Program Director for the Beyond Budgeting Round Table (BBRT)

Throughout my ten part blog series I have been discussing how CFOs can use new technologies to help leverage the finance team in providing greater organizational value. In the capstone summary I also wanted to note that underlying each of the changes discussed is a theme of greater collaboration.

Businessman and businesswoman using digital tablet in office

In many ways technology is enabling this collaboration. But your speed of adoption will increase if you start with a spirit of collaboration before any implementation begins:

  • A strong CFO looks to collaborate with his or her key lieutenants. More effective plans are developed when everyone is looking to optimize the whole organization.
  • A strong corporate finance team looks for ways to team with the business units they support. How can information be shared across units to make the whole stronger than the individual parts?
  • Strong finance teams also look to gain advantage by teaming up and down the value stream. For instance, the concept of eliminating duplicate data entry extends up and down the value stream. Why re-key a key vendor’s data or ask your customer to re-key yours?

New technologies such as integrated planning modules are leveraging collaborative work flows which are often imbedded into the design of new modules. These systems provide real time status of work flow which can be tracked automatically. Group messaging and polling functions facilitate online dialogues which can be happening with people around the globe. Joint work efforts can be tracked by automated audit trails maintaining change history. Teams can access the organization’s knowledge bases though on-line content management systems – anytime, anywhere. Even security concerns are better addressed as prepackaged solutions build in the security checks.

Old approaches that relied on linked spreadsheets had finance teams constantly trying to validate if they were working on the right numbers. Past surveys [1] have estimated that FP&A teams spend 47% of their time collecting and validating date. They spend another 30% of their time administering the planning process. As a result, they only have 23% of their time to do any real value added planning work. The new technologies we are discussing (mobile, in-memory, predictive analytics, and cloud) can flip this equation leaving finance teams free to focus just on collaborating and doing real planning work.

In addition to collaboration, success with these new technologies requires three key elements. The first is leadership and whether they are willing to explore new ways that finance can improve organizational value. This is likely a CFO who is looking to have greater impact. The second is an organization with a willingness to change. In addition to collaborating, there also needs to be an openness to what is possible. This leads to the third element which is experimentation. As Peter Drucker advised, systemic innovation “consists in the purposeful and organized search for changes, and in the systemic analysis of the opportunities such changes might offer for economic or social innovation.” [2]

Whether you are a CFO or just someone in looking to add greater value, ask yourself these questions:

  1. What changes should we be making to expand the value our finance team creates?
  2. How should our planning, budgeting and forecasting process change to take advantage of the next generation planning tools already here?
  3. How can in-memory computing help us harness Big Data for greater insights?
  4. What predictive analytics will provide us with greater lead time for improving?
  5. How can we better reach our strategies by aligning our execution efforts? What should be dropped to create capacity for what needs to be added?
  6. Which customers provide our current profitability? How will that change in the future?
  7. How can we improve the return on all expenditures?
  8. How can we eliminate wastes by moving to real time consolidation?
  9. How can we increase our response times using real time close and disclose approaches?
  10. How can finance improve collaboration?

Finally, how can finance find the time to pursue these goals? That begins with your leadership and identifying dumb stuff you are currently doing that should stop. I hope this series of blogs have helped get you started.

[1] See joint studies by APQC/ Beyond Budgeting Round Table (BBRT) and by Business Finance Magazine and BBRT. See “The Budget (1922 – 2009) Is Dead” by Jack Sweeney, Business Finance magazine, June 1, 2009.
[2] Drucker, Peter, Innovation and Entrepreneurship: Practices and Principles, (New York: Harper & Row) 1985, page 35.

Steve Player

Integrating Financial Analytics with Operational Transfer Pricing to Optimize After-Tax Profitability – Part Two

From Rob Jenkins, SAP Global Center of Excellence

In my previous blog, I discussed a variety of financial planning and tax modeling requirements and the disparate analytic tools finance teams are using to achieve their objective of partnering with the business to optimize decision making. Today, I want to discuss the rise (again) of profitability and cost management software.

For more than 20 years, profitability and cost management software has served a niche in finance and operations where organizations needed to model complex business rules of cost assignment, attribution and allocation in multiple process steps using driver volumes and multi-dimensional views. These data inputs often include financial values and non-financial measures by department, account, process, customer and/or product components in multiple layers all the way down to the bill-of-materials.

Gartner refers to this application space as Profitability Modeling and Optimization (PM&O) – part of corporate or enterprise performance management. These enterprise applications enable business users to use a point and click interface to rapidly build profitability and/or cost models and leverage built-in reports and OLAP (online analytical processing) multi-dimensional database for storage. Originally developed for activity-based costing purposes in the 1990’s, these PM&O applications have been adapted over the years to enable any methodology of complex revenue or expense allocation using a multi-dimensional database environment.

Organizations can transform source financial data where revenue and expense are typically captured in disparate dimensions into aligned, common dimensions. For example, revenue is captured by product and customer in a billing system whereas most expense is captured in the financial system by responsibility center without direct linkage to “market-facing dimensions.”

This transformation can incorporate robust rule sets that are visually depicted and easily maintained while accommodating large data sets. These types of models would be onerous to build, document, and maintain in spreadsheet software or would require IT to build a custom OLAP application with user interfaces and reporting tools.

Planning systems can be configured to import actual data and apply complex rule sets though the interface and dimensional data model are not pre-configured for multi-step, activity-based cost allocation purposes.

Integrating Planning Systems with Profitability and Tax Impact Modeling
PM&O applications can easily handle integrating budget, forecast or other scenario data using the version dimension. This enables alignment of planned financial data with actual results for revenue and cost following the mapping from resource center or account to process all the way to customer, product or other business dimension. Planned data can include financial data and driver-volumes or different capacity estimates if changes in operations or efficiencies are targeted.

PM&O applications have seen a recent resurgence given the applicability to modeling detailed operational transfer pricing rules. These rules are structurally very similar to activity-based methods and include robust, multi-step, driver-based allocation of shared cost pools along with the capability to model the detailed supply chain process steps and the tax impact based on jurisdiction, rates, etc

These applications can provide one integrated financial modeling solution that serves both FP&A and corporate tax enabling collaboration on inputs, rules and a single source of truth. With the proper configuration, an implementation team can create an accurate, documented view of pre-tax product / customer margin based on the true “economic map” of the business along with a tax-impacting process view of transfer prices, debt location, IP royalties and passive income.

The calculations can include actual results and “what-if” scenarios for the executive team to strategically organize global resources and operations.

So while taxes are a certainty, corporations will continue to deploy capital to maximize after-tax return on investment and finance organizations will be able to continue to use technology to be a strategic partner in modeling decisions and optimizing outcomes.

I’d like to hear your thoughts…where do you see financial analytics software heading given the convergence of planning, profitability and operational transfer pricing?

Is Your Finance Organization a Big Data Dinosaur?

Coffee-break with GameChangers

By now, every finance executive is hyper-aware of the bevy of business intelligence tools that help collect and analyze Big Data – but many are just not equipped to leverage them. First, they need to grasp fundamental planning points by rethinking the approach to data and finance’s role in the business.

In a recent SAP Game-Changers radiocast, Gary Cokins, founder of Analytics-Based Performance Management; Jon Essig, CPA with Optimal Solutions; and Rob Jenkins, global finance technology leader at SAP, offered advice on how to predict profitable performance in challenging times.

You can’t solve a problem you don’t understand

All panellists agree that there is a distinct resistance to change in the finance world – and this makes organizations ill-equipped to deal with emerging data challenges posed by innovative technology.

According to Cokins, “We need to close what I consider the wide gap between the CFO and the CMO, because the key is marketing has to answer the question: What types of customers do we basically retain, do we grow, do we win back, do we acquire? We are going to have to see that gap gets closed by finance and accounting function providing more and better information about customer profitability levels.”

Essig thinks there is a good chance at closing that gap, since tools are getting easier to use and require less expertise. The new workforce is also more comfortable interfacing with new technology.

Jenkins, however, still sees data interpretation as a big stretch in finance. “Getting to a fully absorbed profit view by product or by customer takes a lot more judgment and a lot more imagination and it really is worth the effort, but we don’t see a lot of firms doing that.” The fundamental issue is figuring out what to do with all the data to make it valuable and improve planning and forecasting.

Take the risk on technology

Essig believes that the next few years will bring the risk-averse finance sector further along in software investment. As tools become more available and cost-effective, “You no longer need the higher teams of the consultants and data scientists to come out and invest hugely in a project to benefit from these tools.”

According to Jenkins, you can achieve a near-forensic view of product and customer profitability with increased computing power that proves its merit in the form of improved decision making.

One implication of such a shift could mean the end of the dreaded annual budget. Instead, progressive economics and management accounting pave the way for rolling forecasts at more frequent intervals, providing a fresh perspective.

As a new era of tech-savvy CFOs is ushered in, technology will be seen as an enabler instead of a barrier. What do you think are the possibilities once this shift is completed? Listen to the full radiocast for more details.

Integrating Financial Analytics with Operational Transfer Pricing to Optimize After-Tax Profitability – Part 1

From Rob Jenkins, SAP Global Center of Excellence

Benjamin Franklin once noted “In this world nothing can be said to be certain, except death and taxes.” Finance professionals must deal with uncertainty as they model the future and partner with the business to optimize decision making. And while taxes are a certainty, tax jurisdiction and therefore tax rates are a function of how and where a business process is executed and assumptions made by the business. And those assumptions should be well documented for regulatory agencies.

Every for-profit entity’s objective is to deploy capital to maximize the after-tax return on investment. This requires a tight collaboration between financial planning and analysis (FP&A) and corporate tax functions to provide insight into the past and potential economic profit of products and customers and the available possibilities of organizing operations to maximize after-tax profit.

Many companies are in the news for performing “tax inversions” as part of a strategic acquisition of a non-US-based entity due to U.S. rates now exceeding the simple average of other OECD nations by 14.1 points and the GDP-weighted average by 10 points. [1]

Modeling After-Tax Financial Impact of Business Operations
Given the disparity in global tax rates, process and asset location along with transfer prices can have significant impact on after-tax income. Various operating scenarios can result in “profit shifting” among tax regimes and the business analyst can calculate the impact on statutory results by modeling the following:

  • Whether a business activity is active or passive
  • Where activities occur including R&D and “management”
  • The location of intellectual property
  • Placement of debt and borrowing costs (thin capitalization rules)
  • Transfer pricing (inter-company pricing arrangements between related business entities)

Choosing the Right Tool for the Task
A variety of tools are available to enable business users to estimate financial outcomes based on input variables and assumptions about their systemic relationships.

Spreadsheet technology is ubiquitous in finance for ad hoc modeling with some companies building complex, interdependent workbooks with macros for automation and detailed documentation for knowledge management, while others rely on a single subject matter expert to maintain the “black box”. These webs of interconnected cells and sheets are notorious for their error rates and hardwiring with one study finding “errors of at least 5% were found in 91% of all spreadsheets with more than 150 rows.” [2]

My previous blog post, Big Data for Finance, referenced how Big Data and analytics can be utilized to model the future based on historical data relationships and advanced analytic algorithms – though few finance organizations have yet to embrace the suite of predictive analytic tools now targeted at the business user.

Managing the Scope of Planning, Budgeting and Forecasting Systems
However, most finance organizations are using enterprise software applications for planning, budgeting, and forecasting with a large number of firms incorporating driver-based techniques for quantifying revenue forecasts and gross margin (for example, estimated product volume x selling price and standard cost for cost of goods sold).

For planning indirect operating expense including the cost to acquire, serve, and retain customers, the vast majority of companies budget expenses by function, responsibility center, and account, and rely on streamlined allocations to create a pre-tax operating margin view with most management attention focused on “controllable margin.”

These enterprise planning systems are extremely valuable for gathering inputs from decentralized sources, managing workflow, recording audit trails, aggregating actual results, calculating budget variances and reporting multi-dimensional financial statements for management.

Since FP&A teams are traditionally focused on financial reporting aligned with GAAP or IFRS requirements, these planning systems are rarely configured to calculate the detailed dynamics of how hundreds or thousands of shared indirect labor or overhead cost pools are attributed (sometimes in multiple steps) to products or customers based on usage-based drivers or activity-based methods.

Nor do these systems typically account for the tax impact of supply chain logistics, asset location, and transfer prices. Complex driver-based attributions and operational transfer pricing have been the province of cost accounting and tax accounting, respectively, and rely on specific techniques, operational data sets and levels of detail not ordinarily integrated into corporate planning systems.

The result is that most FP&A and tax teams use separate systems to plan and model pre-tax economics at a high-level vs. a granular view of profitability by customer and product vs. the tax impact of how business operations are organized.

So, what’s the solution? In my next blog, I will discuss operational transfer pricing and the rise (again) of profitability and cost management software. Stay tuned!

[1] Tax Foundation, OECD Corporate Income Tax Rates, 1981-2011, http://taxfoundation.org/article/oecd-corporate-income-tax-rates-1981-2011.

[2] http://www.isaca.org/Journal/Past-Issues/2007/Volume-1/Documents/jopdf0606-controlling-spread.pdf

 

Costs that Increase Returns

From Steve Player, North America Program Director for the Beyond Budgeting Round Table (BBRT)

Last week looked at profitability. This week we look at the same objective but with a sharper pencil. Want to see how to make sure that your costs increase your returns? Then read on.

Over my career I have had the privilege to work with several well managed financial services companies including investment firms, banks and insurance companies. The first time I worked with them I learned that when they discussed their CIO, they were not referring to information technology. Instead they were describing the chief investment officer which is a position focused on the strategy needed to generate appropriate returns on the organization’s holdings generating interests, dividends and other income necessary to meet future obligations.

increasing returns

Our world requires all CFOs to also serve as Chief Investment Officers. Nearly every out flow of cash – whether called an expense or an investment can be examined for the return it helps generate. What we typically call expenses are merely maintenance investments made to keep processes running as intended. Organizations need raw materials and supplies, including labor based inputs to feed processes and create products and services that customers value and are willing to pay for receiving.

Analyzing Cost Information

Cost information needs are currently met by two different types of systems. The first are transactional systems such as those embedded in your Enterprise Resource Planning (ERP) system. These systems provide costing information by creating a series of transactions that track the movement of items within the production process. Each step adds a little more cost based on the decision rules set up in the system. Understanding the incremental investments becomes an exercise in tracing the steps in the process and determining what might be done more effectively.

In the early days of the industrial revolution, the amount of work that this transactional approach took made it too costly to use on a regular basis. So standard costing rules were applied at an aggregate level to approximate the costs. The standard cost approach also enables cost estimates to be used in advance of knowing precise amounts from each invoice. The goal was to get reasonably close approximation of the distribution of the production costs. SAP’s CO-PA module follows this approach. If actual costs are materially different from the estimates, an upward or downward adjustment is made to ending inventories to properly state inventory balances.

As product complexity increases in terms of the number of processing steps, the sharing of common manufacturing facilities, the sheer variety of products and services produced, etc., this transactional approach becomes more difficult to execute. While computing power has continued to increase, the volatility of commodity prices combined with product and process complexity have made this static annual or quarterly view of individual product and service costs estimates less reliable.

In the mid-1980s frustration with the problems of the transactional approach led to the development of activity-based costing (ABC) which takes an analytical approach to costing based on how activities are combined to create goods and services. This approach breaks cost movement into at least two stages. The first tracks how the cost of resources (i.e. people’s time) flows into activities (the work they do). The second step then tracks how these activities are linked to the products created and services delivered. This gave rise to ABC software such as ALG Group’s Metify solution (which evolved into ALG’s EPO – enterprise performance optimization – EPM tools)[i]

The commonality between these two main approaches to costing is that they each seek to help understand the cause and effect relationships of how resources (the cost inputs) are used to create outputs. As technology has gotten faster and faster, the levels of detail that can be examined have grown exponentially. There will be a huge desire by some practitioners to focus the increasing power of in-memory computing on running existing costing processes faster.

Improved Cost Visibility Allows CFOs to Focus on Straegic Initiatives

Better costing however, is more than just faster calculations and greater detail. In the future, CFOs who are chief investment officers can use this new computing power to improve visibility by performing additional analysis that will help them:

  1. Identify activities as strategic – Not everything we do is strategic. Some things must be done just to keep things moving. Others are required because of government mandates. These later two categories should be done as quickly and efficiently as possible or considered as candidates for outsourcing so management can focus more of their time on strategic activities that truly differentiate the organization. I experienced this at Hewlett-Packard where they systematically outsourced all warehousing activity to focus their human and financial capital on product innovation.
  2. Focus on customer value added activities – Those things you do that directly impact customers have far greater potential to build or destroy your relationships with them. Perform analysis to best determine what spending will generate the most favorable responses from your customers. The side benefit is you can better understand what specific customer activities are generating positive returns or just generating more work.
  3. Focus on maintenance versus building new capabilities – Are you keeping the existing operation running or expanding your base? All existing operations mature over time and eventually begin to decay. Make sure you are also investing in your future.
  4. Understand any mismatches – There are often differences between how we acquire resources and what we really need in the business. For instance, organizations typically hire full time employees at 40 hours per week. Many times the organization needs a more flexible pool of labor to deal with fluctuating demand.
  5. Compare activities internally and externally – By benchmarking activities and processes you can quickly evaluate sources of competitive strengths and weaknesses. Exploit your advantages while closing your gaps.
  6. Understand timing and how it impacts the competitive position – How quickly can cost structures change, both yours and your competitors? What’s the difference between sunk costs, fixed costs, and variable costs – and across what time horizons?
  7. Identify pockets of idle capacity – How can savings opportunities be consolidated so they can be captured? What is the difference between blue money (potential opportunity) and green money (which can be captured and harvested)?

Next week, we move on to more traditional CFO roles looking at closing and consolidations. You will find that technology is changing them as well.

[i] ALG Software (originally named Armstrong Laing Group) was acquired by Business Objects in 2006. In January, 2008, SAP completed its acquisition of Business Objects bringing all these products together. For a look at the types of analysis ran see Cornerstones of Decision Making: Profiles in Enterprise ABM by Steve Player and Carole Cobble, (Oakhill Press, Greensboro, N.C), 1999.

Steve Player

Achieving Profitable Processes

From Steve Player, North America Program Director for the Beyond Budgeting Round Table (BBRT)

For most organizations today, the most important strategic objective is: profitably executing processes. This need creates a critically important role of Chief Profitability Officer (CPO).

This objective has existed for a long time, even before we had CFOs yet alone CPOs. In 1494, Luca Pacioli wrote a book on mathematics which included 27 pages on what became known as the Venetian style. We know this work today as double entry book keeping. It helped the rising merchant class keep track of profits from their trading voyages. Guttenberg’s printing press, invented around 1450, enabled Pacioli’s book to be printed and speed the use of his ideas.

guttenberg press

Techniques have continued to evolve. In the late 1700’s the industrial age began with the creation of mass production factories. These factories required larger enterprises which led to the creation of joint stock companies, which in turn led to formalization of the accounting profession. Eventually, this resulted in development of cost accounting systems to allocate the costs of production activities to the goods being produced.

As products and services became more complex, the weaknesses of simple cost allocation approaches became more apparent. This was best articulated by Tom Johnson and Robert Kaplan in the 1987 classic Relevance Lost: The Rise and Fall of Management Accounting. These events helped launch the modern age of activity-based costing (ABC) which links activities to the products and services they support. Development (of ABC) was greatly accelerated by inexpensive personal computers that assisted accountants in analyzing accounts and activities.

At every step, technology has been a key to enabling better ways to manage. Today, with the advent of in-memory computing (IMC) and better visualization tools, our world is on the brink of even more dramatic developments in understanding profitability.

Here are four examples of how to get a better understanding of profitability today:

  1.  Run cost allocations at significantly faster processing times. Lenovo[i], the world’s second largest PC vendor, uses SAP’s in-memory computing tool (HANA) to process 1.8 million contract records in just a few seconds. Early attempts at implementing activity-based costing often required significant lag times to process the ABC allocations. These delays impeded adoption. With in-memory processing, these prior challenges have been overcome.
  2. Visualize cost and profit drivers. While rapid allocations are a good first step, management teams really want to understand what drives results. Current tools can be used to graphically depict predictive logic diagrams and systems thinking flow charts. These views improve the ability to see and understand what drives costs and profits.
  3. Forecast and predict the future. Peter Drucker advised us to “understand the future that has already happened.” Proactive CFOs use technology to look upstream to analyze the activities that will create future results. By examining the marketing activities and the sales pipeline, future revenues can be understood. In this way, the rain upstream can be used to predict floods or droughts downstream.
  4. Enable Game Changing at Customer Contact Points. Fashion retailer Charlotte Russe[ii] uses in-memory computing to enable cashiers to boost gross margin at the checkout kiosk. Given the customer profile or a product SKU, the cashier is shown a unique set of upgrade offers and even discounts to offer customers. This in effect can make each employee an expert on the customer standing in front of them.

Proactive CFOs are well beyond just reporting on profitability. They are using technology to understand how the organization processes combine to create it. They are deploying that technology to enable their team members to be game changers in better serving customers.

Next week I will look at the spending side of the enterprise as we address whether finance should focus on costs controls or on making investments.

 

[i] For more details on Lenovo’s approach see http://events.sap.com/sapphirenow/en/session/2441

[ii] For more on fashion retailer Charlotte Russe see http://www.sap.com/pc/analytics/applications/software/industry/sales-analysis/index.html

 

Steve Player

 

What Defines the CFO of the Future?

Coffee-break with GameChangers

It’s no secret that the financial world is dealing with a period of rapid change. Effectively managing these fluctuations is ultimately the job of the CFO – but what does the role of CFO look like now? A recent SAP Game-Changers radiocast explored this question with three panelists. Here are their opinions.

Diversify your duties

“Remain constructively discontent” might be the most useful advice to current CFOs and other financial leaders. This quote from Coca-Cola CEO Muhtar Kent was invoked by Kyleen Wissell, Corporate Director of Internal Controls within the office of the CFO at the Coca-Cola Company. She believes in a culture of innovation and growth – and that starts with strong entrepreneurial mentality at the top levels. Contentedness can lead to complacence, especially in a time of rapid advancement. A watchful eye on possible improvements inherently enables progress.

Elena Shishkina, CFO of SAP UK and Ireland, agrees. She multitasks in as many areas of the company as possible, because, as she says, “I don’t know how my role will look tomorrow. I strongly believe you can only achieve the best outcome for the team and for the organization if you lead with excellence.” Shishkina views herself not just as a leader in finance but a leader in overall business transformation.

Many CFOs now realize that their position is defined by more than a collection of numbers. Richard Sernyak, principle at PricewaterhouseCoopers responsible for the SAP finance transformation practice, concurs that statistics don’t paint a full picture of an organization’s financial health. Greater focus should be placed on unstructured data such as social media. He explains, “What’s important is that not everything that can be counted counts…you need to look beyond the data and really understand what’s important.”

Take control of a new role

The paradigm is shifting as CFOs need to keep up with their traditional, spreadsheet-intensive responsibilities while creating more value for the business. Some of the unique responsibilities now require CFOs to:

1. Act as the lynchpin across the company for presenting actionable information in a dynamic way.
2. Enable proactive, predictive modelling in real time on mobile devices.
3. Enhance performance by spending less time on tasks that don’t provide added value.
4. Look past the numbers to see their context.
5. Take a more holistic view of the business by adopting innovative technologies (which we discussed in another recent radiocast).

Leading a top-notch finance department requires more soft skills than ever before, according to Wissell. CFOs must draw upon emotional intelligence, considering their internal customers, external customers, and opportunities to introduce a pure model that touts more of a specialist view.

As the transformation marches on, all panelists agree that championing technology will become paramount for the CFO. Sernyak sees the role becoming more intertwined with that of CIO as more millennials flood the marketplace and eventually move into leadership positions. Beyond an affinity for fast-paced innovation, Shishkina asserts that CFOs of the future must be culturally aware and sensitive to different aspects of diversity.

That’s quite a list of attributes! So are you a CFO of the future? Listen to the full radiocast.