THE CFO CHALLENGE: DO THE RIGHT TOOLS EXIST?
Startling results from the recent SAICA survey on the ‘South African CFO of the Future’ revealed that more than 70% of CFOs believe that their most important role within the organisation on a five year horizon will be that of planner and strategist. The reason for the alarm bells is that many CFOs today will readily admit that they are poorly equipped to execute this role, particularly as their current systems do not provide the accuracy and decision support capability to perform this function adequately. This article considers the conundrum facing CFOs who cannot trust their data and don’t know where to turn to next by exploring new technologies that have emerged such as Integrated Business Planning (IBP) also known as Enterprise Optimisation.
According to research conducted by Ernst & Young among 250 of the world’s most powerful and influential business people, four key areas of activity for CFOs were:
• being a strategic partner to the board (65%)
• annual budgeting and outlook forecasting (61%)
• risk management (57%)
• business management reporting (51%).
SAICA’s report supports these findings, revealing that the majority of respondents believe that in five years time they will spend even more time on strategic planning, risk identification, trending or predictive modelling, scenario and what-if analysis, as well as corporate performance management – all key aspects related to their role as planners and strategists responsible for shaping the future direction of the organisation.
The problem with Planning as it exists today
The single most important lesson that can be learnt from this current economic downturn is the value of planning. When done well, strategy planning can create a real competitive advantage. However corporate executives, business unit leaders and dedicated planning managers, know all too well that strategic planning does not typically drive a company’s critical decision making process.
According to Richard Rumelt, Professor of Strategy at UCLA’s Anderson School of Management, “Most corporate strategic plans have little to do with strategy. They are simply three-year rolling resource budgets and some sort of market share projection.”
A recent survey by the McKinsey Global Institute on Strategic Planning supports Professor Rumelt’s statement revealing that a mere 23% of a company’s important strategic decisions are made within the recognised strategic planning process. In other words, nearly 80% of a company’s most important decisions are made either by the CEO or by small groups of senior executives, outside the formal process.
The concern is what this can lead to. In the McKinsey survey, corporate executives reported that 17% of the capital invested by their companies went towards underperforming investments that should have been terminated. Another 16% of their investments were a mistake to have been financed in the first place. Even worse, another 21% of capital should have been approved but was not.
Current Planning systems not living up to expectations
A common problem is that most planning systems in use today are not fully integrated. This lack of integration restricts insight and understanding at the enterprise level. Therefore managers cannot evaluate strategic alternatives objectively, nor can they effectively allocate resources. Without understanding the company’s collective performance drivers, managers cannot determine priorities and economic ‘trade-offs.’
Non-integrated systems and inadequate planning and ‘what-if’ analysis capabilities force managers to make decisions without understanding the complete picture. In place of information, management is forced to use well-educated guesses and assumptions; and results from assumption-based activities can be devastating.
Too many companies today make assumptions about costs, customer profitability, product profitability, demand fulfilment capacity, and associated cash flow and balance sheet impacts. In addition to repeatedly poor decision-making, this overload of assumptions also prevents adequate linkage between strategy and execution.
Most strategies include elements for marketing, sales, finance, production and human resources. While these components may be independent, the actions in one area will have an impact on the enterprise, thereby influencing the value of any given strategy. Missing the impact across interdependent strategic initiatives often causes management to miss important nuances and can cause embarrassing and costly mistakes.
The problem is that most companies today operate with standard costing systems, using spreadsheets to evaluate strategic alternatives and make financial planning decisions. Increased complexity of operations, faster market changes and stronger competition are forcing top executives across a variety of industries to re-evaluate the effectiveness of this spreadsheet approach.
Spreadsheets and other systems such as Business Intelligence, Corporate Performance Management, and Supply Chain Management cannot provide the enterprise-wide information required to effectively evaluate the decisions that yield the best overall financial results for companies. These systems are not holistic, they do not accurately represent or optimise for financial impact of decisions, and they do not communicate the right information to all relevant stakeholders.
The reason for this is that current systems provide only a limited view of performance and opportunities, leaving executives with many unanswered questions…
• “All of our investments promise a return of at least 35%, yet our average return for the past 10 years has been under 10%.”
• “We sold more of our most profitable product yet made less profit.”
• “Our company expanded capacity expecting to reduce our costs per unit, yet they went up and our profits decreased.”
Performance management is a difficult task under these circumstances. CFOs cannot understand the top profit drivers and therefore they are less confident of their financial performance commitments. Under this scenario visibility is poor; the CFO is therefore at risk of not meeting financial projections and cannot properly anticipate problems.
The need for Integrated Business Planning or Enterprise Optimisation
Companies should move towards a more comprehensive system that allows managers to identify the decisions with the best strategic and financial impact to the company. An Integrated Business Planning or Enterprise Optimisation system incorporates activity based costing, constraint-oriented process modelling and comprehensive financial modelling to provide an enterprise-wide view of the business that supports all the important strategic and tactical decisions.
The technology analyst firm Gartner defines Integrated Business Planning (IBP) as: “A set of systems, processes, and competencies that forms the strategic alignment and modelling capability that is missing from the traditional operationally focused sales and operations planning (S&OP) processes. IBP links corporate performance management to S&OP, with capability for strategic and financial modelling and analytics.”
Enterprise Optimisation tools model not only processes and operations, but also profit, cash flow, and balance sheet implications, all validated to a company’s financials. To do this, Enterprise Optimisation systems model opportunity values (true economic values) and marginal costs. In comparison, alternative technologies often use assumptions, heuristics and averages to estimate costs and profit implications. Furthermore, other technologies have limited ability to model balance sheet items and therefore cannot accurately measure the real life impact of capital expenditure decisions.
Understanding the business end to end, including operational and financial factors, is critical to properly assessing the opportunities and threats facing a company. Today most companies make decisions in silos without taking into account how this will impact another business unit and also fall victim to a number of unforeseen factors. A holistic model of the enterprise solves this problem by simulating the impact of a decision across the entire physical and financial network, taking into account the relevant constraints and highlighting the real financial impact of a decision.
Typical scenarios that can be modelled with Enterprise Optimisation tools
• What should our profit targets be for the quarter and year?
• Which capital investment decisions best support our targets and how do we identify which opportunities will provide the greatest return on investment?
• Which metrics should we use to set targets? What are the implications?
• What is the impact of changes in supply costs, product demand, new regulations and competitor pricing on our P&L? What should we do as a result?
• What are the opportunities to reduce working capital while maintaining current levels of profitability and cash flows?
• What should our future business model be? Should we acquire/merge with another firm?
The data is there to be used, why not use it properly?
Enterprise Optimisation acts as a decision support engine to make current systems and ERP data more productive by quickly identifying and quantifying the key decisions that will have the greatest impact on future financial performance. It enables stronger decision-making and communication, and identifies the Key Performance Indicators (KPIs) that are worth tracking, and their impact on performance. With Enterprise Optimisation tools, a company can accurately represent its value chain end to end – from the supplier’s supplier to the customer’s customer.
Enterprise Optimisation does not replace a company’s IT investments but rather leverages the data contained in existing ERP or enterprise systems. The technology is typically configured and deployed in a matter of weeks with minimal resources and change management required.
Implementing an Enterprise Optimisation system can lead to significant improvement in performance. Companies that have deployed such a system enterprise-wide have seen as much as a 400% improvement in profits. Unlike other systems, quick wins can be gained in a matter of months.
Enterprise Optimisation systems can provide unprecedented insights that will enable companies to not only take financial performance to a new level, but also to fundamentally change the way their executive teams make decisions and compete in the market. Ultimately it enables CFO’s to perform their new role as strategic planner to the best of their abilities and therefore maximise shareholder value into the long term.
Rod Stout BSc (Hons), is a Director at Business Modellinhg Associates, (Pty) LTD.
THE EVIDENCE OF FIT
“I have no time for you guys telling me that the processes and procedures told you to do this! It is not working! Period!”
As an accountant you must have heard such frustration through the grapevines at your company or while working at your customer. Of course the impact of such frustration will depend on which end of the conversation the frustrated persons sit. For the sake of the story we will assume that their names are Buss and App and both are part of the Exec team. When Buss is the one who expressed the frustration above, then Buss might be driven by the fact that the business just incurred the biggest financial loss due App’s people not doing what they are supposed to do. It will then be App who sits, or rather shivers, on the other side of the conversation (in going through all the steps that the processes dictated to the team… trying to re-assess what went wrong… and why the IT group manager authorised last year’s intensive and expensive IT Governance project in the first place!).
This story comes to the truth. IT Governance projects are mainly outsourced and are time consuming; introduced by IT with high expectations and accompanied by budgets that definitely reads “ROI” all over them. Yet they do not always deliver the perceived value… and as such turn out to be another cost. Sadly all too often IT Governance is seen as a once-off project and not an ongoing process. This results in necessity for management of outdated processes and procedures.
Should we ask IT to stop their attempts to implement Governance, Best Practices and Standards when most of the attempts seem to be fruitless? No! But we should also not let them consume like blind bats, just to satisfy compliancy requirements nor to govern processes that do not contribute to the success of IT and the critical business it serves in the first place. They should be taught to expect a helping hand from colleagues working in a discipline that is not necessarily directly directly related.
Experts increasingly recognise that Chartered Accountants are no longer to confine themselves merely to accounting for past events, but that they have to broaden their horizons in terms of new and evolving concepts like Management Accounting. That practice extends to areas such as Strategic Management, Performance Management and Risk Management and takes a detour from the pure financial checks and balances to the more forward looking and decision orientated, information “value-creators”. Management Accountants shift the emphasis from the historic area of internal controls, audits and compliancy checks to a level where performance on compliance is challenged against the contributing value to the (future) business. And that is where IT can draw its lessons when embarking on implementing IT Governance processes or executing audits on its practice. Learn to apply one basic rule: Always address the Evidence of Fit! Let us explore what we mean by that.
Evidence, in this sense, is finding the proof that IT processes and Governance structures are in place and properly documented. It also extends to (randomly obtained) proof that operational adherence to and compliance with these documented governance structures and processes is according the expected and (documented) outcome. But the most important part of that evidence is questioning the FIT of it (or IT) towards the actual business objectives and resultant requirements. Bridging the IT performance from the cost perspective side to the value proposition is governing if the bridge fits and serves its purpose. It is of no value to the business when incidents, changes and investments are managed and applied in compliance with the documented generic processes but in reality do not address the immediate business pressures and actual needs.
There is definitely a role that Management Accounting can play in educating the organisation in general, and IT specifically, on how to govern the structures that contribute towards the strategic intent of the business. Applying the basic “Evidence of Fit” rule will help you on that journey.
And remember, collaboration and interrogation might not always go hand in hand. But that is for another time…
Jan van Ommen, Director Governance, Risk & Compliance, Aptronics (Pty) Ltd.