Gary Cokins
7. The CFO’s Expanding Role – Reality or Delusion?
Am I alone in wondering if the many references and articles concerning the CFO’s emerging role as a “trusted advisor” is more hype than reality?
Increasingly, I read articles and research studies alleging this emerging CFO role to be actually happening. In an article written by Gianni Giacomelli, senior vice-president at Genpact, titled “Can a CFO Innovate?” he states:
“Modern financial executives are moving toward a more central and expanded role as stewards of the company's longevity, using the finance function to enable growth, especially in new markets and in response to market changes. For those who are ready for change, the new finance is an exciting and rewarding way to help shape a more intelligent enterprise that is better connected to the market and its customers.”
Really? Just to be a devil’s advocate for a moment, what proof do we have that Gianni’s observation is true? When we cut to the chase, what are CFOs more concerned about – regulatory compliance or organizational performance improvement? Certainly, many CFOs monitor and report on performance using scorecards and dashboards. But do they actively participate in assisting line managers to move those dials. As examples:
- Do they assist sales and marketing managers with identifying which types of customers to retain, grow, win back, and acquire?
- Do they assist operations managers to determine which productivity actions and projects will realize gains in efficiency, effectiveness, quality, and cost reduction?
Or do they simply serve as gatekeepers and keep score?
Bean counter or bean grower?
In an article by Myles Corson, a consultant with the Financial Accounting Advisory Services of Ernst & Young LLP, titled “The Evolving Role of Today’s CFO”, he writes:
“In addition to overseeing the company's financial health, CFOs are increasingly involved in setting operational and commercial strategy, navigating their companies safely through tighter credit markets, more complex regulation and unstable trading conditions. … As organizations continue to adjust to market volatility and economic uncertainty, CFOs must increasingly provide expert advice to support boardroom decisions. In fact, many CFOs feel that they are in an exceptional position to offer this level of strategic counsel because of their ability to gather information from disparate parts of the company.”
But is this evolving role one of just better reporting or one creating a greater impact on analysis and decisions?
In a survey conducted by Mary Driscoll of the America Productivity and Quality Center, titled, “A New CFO Priority,” she writes:
“Surprisingly, only five percent of survey respondents believe that finance is currently delivering game-changing value to their enterprises. Is this cause for concern? … Finance organizations that are seen as a partner to the business generate thoughtful, clear, and authoritative analyses. However, the biggest barrier preventing business partnership is the lack of time to perform this same work.”
My intent is not to be a naysayer and deny there is truly an evolving and expanding role of the CFO. In fact, my intent is just the opposite. I am a believer that, particularly given the opportunity provided by the connections of technological forces ( advanced analytics, cloud, in-memory computing, mobile and social computing) the CFO’s finance and accounting function is uniquely positioned at this moment in time to accelerate the adoption rate of enterprise and corporate performance management (EPM/CPM) methods along with emerging business analytics to gain crucial insights that were previously inaccessible and truly facilitate business innovation in new and novel ways. Finance and accounting professionals have developed a strong quantitative aptitude – which technology will only further fuel.
Delusion or reality?
But do we know or just think we know? Which is it - delusion or reality? I bemoan the slow progress in performance improvement methods such as the adoption of activity-based costing (ABC) principles. If ABC is done at all it is typically only taken as far as product and service-line gross product profit margin line reporting and does not look beneath that line to report and analyze channel and costs-to-serve for arguably more critical customer profitability reporting and analysis. And what about marginal / incremental expense analysis for that matter? This involves classifying available / used resources as sunk, fixed, step-fixed, semi-variable, or variable. This involves an understanding managerial economics, not just managerial accounting. How many finance organizations have built core competencies in these functions? My suspicion is that many finance organizations are for the most part dealing with more fundamental problems and have yet to build core competencies in many of the practices espoused by analysts, consultants and business pundits.
For now though, my opinion is the CFO function is about to enter a golden age of business analytics and managerial accounting. But we need more evidence. Are CFOs taxiing on the runway, or have they begun lift-off?
This article was previously published on https://www.information-management.com
6. How Many Types of Key Performance Indicators (KPIs) are There?
It seems the Holy Grail for scorecards and dashboards seem to be organizations seeking to answer, “What should our key performance indicators (KPIs) be?” At the heart of selecting KPIs should be their linkage to the executive team’s strategy. However, there are different stakeholders in an organization, such as internal managers and investor governance boards. Each stakeholder has different needs. Hence there should be different types of KPIs for different purposes.
Performance measures reported in scorecards and dashboards is one of the core components of integrated enterprise and corporate performance management (EPM/CPM) rivaling in importance other improvement methods such as customer relationship management and managerial accounting. Regardless of the type of KPI, analytics (such as segmentation, correlation, regression, forecasting, and clustering) should ideally be imbedded in each method, and they are critical for employees to achieve and exceed KPI targets.
Author Brett Knowles, founder of the consulting firm PM2 (https://www.hirebook.com) and a veteran of the balanced scorecard thought leader community, has given much thought to the topic of different KPIs for different purposes. In Volume 4, Number 6 of his firm’s Performance Measurement &Management newsletter Brett describes different types of KPIs in an article titled “Five Distinct Views of Scorecards – and Their Implications.” With Mr. Knowles permission, here they are abbreviated with my minor edits:
- Financial Valuation – A scorecard view is needed to describe what the organization does in a way that the financial world can understand: monetary currency (e.g., dollars, Euros). All activities need to be financially valued, including tangible assets (e.g., buildings and inventories) and intangible assets (e.g., brand equity, employee retention, and customer loyalty). Several methodologies exist that grapple with this need, including economic value added (EVA) and activity-based costing (ABC).
The challenge is that more than 80% of value is created by intangible assets, yet traditional accounting systems do not do a good job of capturing intangibles. The balanced scorecard has proven to be a great tool for making the intangible assets visible and valuable.
Information in this area needs to be:
- Centered on outputs, outcomes or deliverables,
- Closely related to existing valuation mechanisms,
- Standard, repeatable and reliable.
- Navigation – Internal managers need to make informed decisions on a frequent basis that are consistent with the medium- and long-term strategy. Strategy, cascaded downward into the organization through a strategic balanced scorecard and into operational dashboards, dictates both what should be done and how important it is. This view of performance measures creates alignment of employees’ actions and priorities across all functional and regional boundaries and consistency across time. This is where the EPM/CPM methods with imbedded analytics play a critical role.
Information in this area needs to be:
- Very responsive to shifts in the work activities,
- Process based,
- Related to overall effectiveness and efficiency.
- Incentive Compensation – Scorecard frameworks lend themselves to rewarding employees for contributing to the success of the organization. Over-performers should be distinguished from under-performers. A key to this view is for the executive team to assign aggressive yet achievable target measures.
Information in this area needs to be:
- Related to the value that the team can control and create,
- Output and outcome related,
- Accurately measurable and repeatable across locations and time.
- Benchmarking – An effective way to determine whether an organization is making progress is to compare it to other “things” (“comparatives”). There are many comparatives available: competitors, best-in-class, world-class. In the true sense, even target, forecast and revised-forecast are all comparatives too.
The challenge with the benchmark view of scorecards is that the data is sparse and with “dirty” quality. Also, there can be apples-and-oranges inconsistencies (e.g., including or excluding data, measuring different start-and-end times of processes). Comparatives do not typically go into enough detail to provide operational insights into diagnosing any identified issues and root causes, nor do they cover the full breadth of the executive team’s strategy.
Information in this area needs to be:
- Available from other sources,
- Understandable and relatively comparable,
- Strategically related to the organization.
- Evaluation – Periodically, there is the need to get an accurate measurement of how the organization is performing. Periodically the organization needs to undertake such activities as customer surveys, employee surveys, supplier assessments, etc.
These activities are too expensive and time consuming to be conducted often enough to be useful for navigation, but can be used to underpin selection and validation of navigation indicators, support incentive compensation models and be used in reporting performance to outside stakeholders.
Information in this area needs to be:
- Survey based,
- Comprehensive and rigorous,
- Closely related to overall deliverables.
Brett summarizes his five views by stating that most organizations need to consider their organization’s performance in two or more of these views. For example, a shared service IT department may need to prove and measure its contribution to the organization’s overall valuation, provide monthly navigational information for the project managers (and service level agreements [SLAs] for their internal customers), and develop a compensation package for use around the globe. They may also need to compare themselves to industry benchmarks.
The various and numerous stakeholders need to initially develop some confidence that the scorecard model adequately describes their view of the organization. Consider building the various views as a way to speed implementation of a pilot scorecard. A simple way to do this is to create a single enterprise-wide strategy map, but link different indicators to it for each of the views.
My feeling is Brett is on to something important. As I have previously written there is confusion and lack of consensus as to what a balanced scorecard is. There is ambiguity. Further many organizations neglect to first construct a strategy map from which to derive its KPIs. A strategy map is orders of magnitude more important than its companion balanced scorecards and cascaded operational dashboards. They are simply feedback mechanisms.
Understanding that there are multiple scorecard views can bring clarification.
This article was previously published on www.epmchannel.com
5. Does Accounting Undermine Managers' Ability to Make Good Decisions?
By Gary Cokins and his IMA CMCQ task force member colleagues
The Center for Managerial Costing Quality aspires to help management accountants and the broader business community recognize and understand the need, the benefits, and a path forward for improving cost information for internal decision support. Our goal is to establish “managerial costing” as a unique and specific function and discipline within the accounting profession with distinctly different principles and requirements from GAAP and external financial accounting.
This website is not just for accountants. It provides resources for the many diverse stakeholder groups affected by the quality of their organization’s managerial costing practices. We encourage you to use the resources available here learn more about how this issue affects the performance of your organization and what you need to do.
There is a misconception that costs are accurate. Information generated by financial accounting-focused systems is limited to organization-wide measurements and often fails at even basic levels of granularity. As a result, profitability by product, service-line, channel and customer is misstated. Cross-subsidized costs are rampant with misallocations—making profitable business divisions or products look bad while unprofitable business lines look good. Effective business portfolio management is difficult in these circumstances.
Further, the usefulness of information is severely limited. Financial accounting-focused systems fail to measure costs of core aspects of the business. By failing to link costs with causes, the unavoidable results are misleading profit margins, unrealistic budgets and forecasts, as well as ill-informed insourcing, outsourcing, offshoring, capital spending and other critical management decisions.
The persistence of 20th Century management accounting practices and systems into the 21st Century is not due to the absence of better, more relevant accounting models. For several decades, management accounting thought leaders have been developing new, more effective models to meet the needs of organizations competing in a worldwide and highly-competitive marketplace. However, the majority of practicing accountants are unaware of, or are ignoring, these superior methods and concepts. As a result, decision making is weakened.
Management accounting practices need to advance. Accounting systems can and should reflect underlying managerial economics that are essential to guiding an organization to higher levels of success. For too long the accounting profession has fallen behind other business disciplines in its commitment to building and sustaining value. It must now move into catch-up mode to provide managers with accurate and useful information based on cause and effect relationships.
Decision makers should demand better managerial costing from their accountants to manage performance and profitability of products, service-lines, channels, customers and their supporting processes. Simply “adjusting” compliance-focused financial accounting systems and traditional costing practices won’t work. It’s an ineffective solution to the larger problem. Better and more robust information is required to make decisions and take action that builds value in an organization. That information is available, but accountants must be committed to, and managers must demand, 21st Century managerial costing solutions.
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4. A Passionate Appeal for Activity-Based Costing (ABC)
Usually I am fairly rational and do not let my personal emotions interfere with how I interact with others. However, as the readers of my blogs and articles may have detected, my more recent writings increasingly reflect my frustrations with old school accountants. I cannot disguise my irritation and annoyance with accountants who refuse to be progressive.
Several of the titles of my articles these past few years provide hints and clues as to the source of my frustrations. They include “Are Accountants Homo Accounticus?”, “Some Accountants are the Blind Leading the Blind”, “Movie Sequel – Pirate Accounts of the Caribbean”, “Cowboy Accountants – The Lawless Frontier”, and “Do Accountants Lead or Mislead?”
Each time I post an article I’ve written like those I receive several personal e-mails that are supportive of my view. Some are even more vitriolic. Receiving these e-mails, and also the publicly posted website comments to my written pieces, further motivates me to continue broadcasting my message of frustration often shaming accountants. I call it MBE or “management by embarrassment.”
At this point some of you may be asking yourself, OK. What the heck is bugging Gary that he is so frustrated about?” The simple answer is it is the slow adoption rate of applying activity-based costing (ABC) principles as a replacement for the flawed and misleading traditional “cost allocation” methods from standard cost accounting systems. They typically use non-causal cost allocation factors. Examples are the number or amount of direct labor input hours or currency, units produced, sales volume, headcount, or square feet/meters.
Benefits from applying ABC in comparison to traditional cost allocation methods that violate “costing’s causality principle” are too numerous to list here. Key benefits are: (1) extremely more accurate profit and cost reporting of outputs, products, services, channels and customers; (2) transparency and visibility of the “drivers” for work activities and their magnitude; and (3) past period calibrated cost consumption rates that are essential to multiply against future forecasted demand volume and mix that determine resource capacity requirements – workforce headcounts and spending amounts. These rates are needed for what-if scenario analysis, make-versus-buy decisions, and capacity-sensitive driver-based rolling financial forecasts and budgets.
Causality is at the heart of ABC. For example, if the quantity of the activity driver increases 20% then its activity cost should also increase 20%. The work activities are what consume the resource capacity expenses. My opinion is that any CFO/ financial controller or FP&A analyst who are using traditional cost allocation methods and are not using ABC where it is applicable (which is for most organizations) is being irresponsible in their duty to provide valid information to managers and employees. The information they are providing is faulty, distorted and deceiving. Line managers deserve better to support their decisions.
Now read the first letter of the six prior paragraphs as if together they are a two word sentence. My message is blunt: USE ABC !
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3. Put Your Money Where Your Strategy Is
Two easy ways for executive teams to attempt to raise profits is to lay off employees to cut costs or to lower prices to take away market share from their competitors. But these are merely short-term fixes. An organization cannot reduce its costs and prices to achieve long-term sustained prosperity.
Entrepreneurs know the age old adage “you need to spend money to make money.” However, belt-tightening an organization’s spending can be haphazard. Rather than evaluating where the company can cut costs, it is more prudent to switch views and ask where and how the organization should spend money to increase long-term sustained value. This involves budgeting for future expenses, but the budgeting process has deficiencies.
A problem with budgeting
Companies cannot succeed by standing still. If you are not improving, then others will soon catch up to you. This is one reason why Professor Michael E. Porter, author of the seminal 1970 book on competitive edge strategies, Competitive Strategy: Techniques for Analyzing Industries and Competitors, asserted that an important strategic approach is continuous differentiation of products and services to enable premium pricing. However, some organizations believed so firmly in their past successes that they went bankrupt because they had become risk-adverse to changing what they perceived to be effective strategies. Wang Labs, Borders, and Blockbuster are examples.
Strategy execution is considered one of the major failures of executive teams. Dr. David Norton, co-author of The Balanced Scorecard: Translating Strategy into Action, has reported, “Nine out of 10 organizations fail to successfully implement their strategy. … The problem is not that organizations don’t manage their strategy well; it is they do not formally manage their strategy.” In defense of executives, they often formulate good strategies – their problem is failure to successfully execute them.
One of the obstacles preventing successful strategy achievement is the annual budgeting process. In the worst situations, the budgeting process is limited to a fiscal exercise administered by the accountants where the budget is typically disconnected from the executive team’s strategic intentions. A less poor situation, but still not a solution, is one in which the accountants do consider the executive team’s strategic objectives, but the initiatives required to achieve the strategy are not adequately funded in the budget. Remember, you have to spend money to make money.
Value is created from projects and initiatives, not the strategic objectives
A popular solution to failed strategy execution is the evolving method of a strategy map with its companion balanced scorecard. Their combined purpose is to link operations to strategy. By using these combined methods, alignment of the work and priorities of employees can be attained without any disruption from restructuring the organizational chart. The balanced scorecard directly connects to individuals regardless of their departments or matrix management arrangements.
Although many organizations claim to use dashboards and scorecards, there is little consensus on how to design or apply these tools. At best, the balanced scorecard has achieved a brand status but without prescribed rules on how to construct or use it. For example, many companies claim to have a balanced scorecard, but it may have been developed in the absence of a strategy map from executives. The strategy map is arguably many orders of magnitude more important than the balanced scorecard. Therefore, when organizations simply display their so-called scorecard of actual versus planned or targeted metrics on a dashboard, how do the users know that those measures displayed in the dials, commonly called key performance indicators (KPIs), reflect the strategic intent of their executives? They may not! At a basic level, the balanced scorecard is simply a feedback mechanism to inform users how they are performing on preselected measures that are ideally causally linked. To improve, much more information than just reporting your score is needed.
One source of confusion in the strategy management process involves misunderstandings of the role of projects and initiatives. For the minority of companies that realize the importance of first developing their strategy maps before jumping ahead to design their balanced scorecard KPIs, there is another method challenge. Should organizations first select and set the targets for the balanced scorecard KPIs, and subsequently determine the specific projects and initiatives that will help reach those targets? Or should the sequence be reversed? Should organizations first propose the projects and initiatives based on the strategy map’s various theme objectives, and then subsequently derive the KPIs with their target measures afterward?
We could debate the proper order, but what matters more is that the projects and initiatives be financially funded regardless of how they are identified. Value creation does not directly come from defining mission, vision and strategy maps. It is the alignment of employees’ priorities, work, projects and initiatives with the executive team’s objectives that directly creates value. Strategy is executed from the bottom to the top. Using a fishermen’s analogy to explain this: Strategy management tells you where the fish are, but it is the projects, initiatives and core business processes that catch the fish.
Four types of budget spending: operational, capital, strategic, and risk
The overarching process begins with strategy formulation and risk mitigation and ends with financial budgeting and rolling forecasts. Some budgets and rolling financial forecasts may distinguish the capital budget spending from operational budget spending, but rarely do organizations segregate the important strategic budget spending and risk budget spending for risk mitigation.
A key point is that the budget depends on and is derived from two separate sources: (1) a future demand-driven source (operational) and (2) three project-based sources (capital, strategy, and risk).
Ideally, the strategy formulation by the executive team uses meaningful managerial accounting information, such as understanding which products and customers are more or less profitable today and are potentially more valuable in the future. With this additional knowledge, the executives can determine which strategic objectives, as mentioned typically displayed in a strategy map with its associated balanced scorecard, to focus on.
The operational budget, those expenses required to continue with day-to-day repeatable processes, is calculated based on forecasted volume and mix of “drivers” of processes, such as the sales forecast, multiplied by planned unit level consumption rates that are calibrated from past time periods (and ideally with rates reflecting planned productivity gains). This demand-driven method contrasts with the too-often primitive budgeting method of simply increasing a cost center’s prior year’s spending level by a few percentage points to allow for inflation. The operational budget spending level is a dependent variable based on demand, so it should be calculated that way.
Regardless of whether an organization defines the strategic initiatives before or after setting the balanced scorecard’s KPI targets, it is important to set aside strategy spending and risk mitigation spending not much differently than budgeting for capital expenditures. Too often, the strategy funding is not cleanly segregated anywhere in the budget or in driver-based rolling financial forecasts. It is typically buried in an accounting ledger expense account. And enterprise risk management (ERM) spending must also be included. As a result, when financial performance inevitably falls short of expectations, it is the strategy projects’ “seed money” and the risk mitigation spending that gets deferred or eliminated. The priority must be reversed. Organizations must protect strategy and risk mitigation spending and allow them to go forward as they are key to competitive differentiation for successfully accomplishing the strategy – and doing it safely.
Put your money where your strategy is!
Managing strategy is learnable
Organizations with a formal strategy execution process dramatically outperform organizations without formal processes for this. Building a core competency in strategy execution creates a competitive advantage for commercial organizations and increases value for constituents of public sector organizations. Managing strategy is learnable. It is important to include and protect planned spending for strategic projects and initiatives and risk mitigation spending in budgets and driver-based rolling financial forecasts. The three types of projects (capital, strategy, risk) lead to long-term sustainable yet safe value creation. Driver-based operational expense planning assures that the correct level of employee head count and spending are in place to achieve planned profits.
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