Financial reporting is the process of describing how businesses earn revenues, incur expenses, and generate cash flows. An objective of financial reporting is to develop insights into profitability, liquidity, and solvency. One way to improve the ability in achieving this objective is through financial planning.
Financial planning can help financial reporting develop insights into profitability, liquidity, and solvency through a chart of accounts. A chart of accounts is a list of names used to record and communicate transactions. Transactions can be recorded and communicated broadly through assets, liabilities, equity, revenues, and expenses. Transactions can be recorded and communicated narrowly through cash, accounts payable, common stock, merchandise revenue, and cost of goods sold. Recording and communicating transactions broadly are processes dictated by organizations like the Financial Accounting Standards Board (FASB), International Accounting Standards Board (IASB), and Securities and Exchange Commission (SEC). Recording and communicating transactions narrowly are processes influenced by the actions of people within businesses.
The actions of people within businesses can be guided by the role of financial planning.
Financial planning can guide actions within businesses based on how revenues will be earned. Financial planning can guide people to think about the types of products that will be delivered. Financial planning can guide people to think about the types of services that will be provided. Thinking about the types of products delivered and services provided can create flexibility within a chart of accounts. A chart of accounts can be organized to communicate revenues broadly, e.g. product revenue and service revenue. A chart of accounts can be organized to communicate revenues narrowly, e.g. food sales and tax services. Creating flexibility within revenues can help people assess strengths and weaknesses within customer relationships.
Financial planning can guide actions within businesses based on how expenses will be incurred. Financial planning can guide people to think about how products will be created, e.g. direct materials, direct labor, and manufacturing overhead. Financial planning can guide people to think about how products or services will be promoted, e.g. public relations, social media, and trade shows. Financial planning can guide people to think about how businesses will be supported, e.g. compliance, communication, and training. A chart of accounts can be organized to communicate these thoughts broadly through production, selling, and administration. A chart of accounts can be organized to communicate these thoughts narrowly through specific initiatives. Creating flexibility within expenses can help people assess strengths and weaknesses within internal processes.
Financial reporting helps people inside and outside businesses to assess financial health. The foundation in this effort is a chart of accounts. The effectiveness of a chart of accounts can be achieved by the role of financial planning.
Edward Hess in his excellent book Learn or Die reminds us that today’s average tenure on the S&P 500 is 18 years and declining. In 1980, the average tenure was 30.
Hess also states through his research that nearly half of the S&P was replaced in the past decade.
How’s that for company relevance?
Then he tells us the average tenure of the Fortune 500 CEO is just 4.6 years.
As an FP&A professional, you might be asking, “What does this have to do with me?” I believe the answer is everything.
Could it be possible that the role of the FP&A professional is just as much at risk as the large companies cited above or the CEOs of these same organizations? Shouldn’t we be asking, “How relevant is my role in the years to come?” Fair question?
Let’s unpack this FP&A relevancy question with a few others that might help.
Author and business consultant, Clayton Christenson teaches business owners that the key to selling more products or services is to know the specific job these goods perform for the customer. In this insightful video, Christenson explains that the job of the milkshake is to keep the driver occupied during a long drive to work while satiating hunger pains throughout the morning. Brilliant.
Let’s apply Christenson’s concept to FP&A. What job is being performed for every FP&A activity you perform? What’s the job of the historical marketing and sales analysis? What job is the driver-based rolling forecast being done for the users of this output?
I’m sure you can add to this list of questions. Accordingly, I believe Christenson’s simple job-to-be-done framework aptly applies to the FP&A relevancy question.
The better you can answer Christenson’s questions in all aspects of your work, the more relevant you are likely to be over the next 5 to 10 years.
I have a theory. I provide CFO consulting services for small, growing companies in the U.S. My gut instincts tell me FP&A relevancy is not at risk, far from it. For me? That’s a different story.
Here’s how I personally attack the relevancy question. I do so with two other questions:
I think I know the answer. I’m not even sure IBM’s Watson has the self-awareness to address this. My answer is that I stay relevant by keeping my clients relevant for a long, long time.
Similarly, I perceive that you, the FP&A professional, stay relevant by keeping your employer relevant. Now work backwards which comes instinctively natural for you—how will you do that?
As a homework assignment, I’d enjoy reading your feedback in our LinkedIn Group about how you are staying relevant by keeping the organization you serve relevant. It’s not about you. It’s about making the business you serve great. You have some of the greatest intellectual capital in the world—the creativity and capability that exists in your mind. Use it and you remain relevant.
How far can you go with improving your FP&A practices? Recently, I have encountered a paper conveyed by Prophix: Defining the Evoluion of FP&A: Benchmarks, Challenges and Opportunities.
In this paper the authors are trying to find the key points that define FP&A evolution, based on a survey conducted among 300 FP&A leaders. The results of the survey are presented in the form of insights, of which they have 7.
I will try not to give too much away, but for me, the most striking insight was the following: ‘FP&A Leaders want better data, better technology, more accountability” (Insight 7).
While reading about this insight, an analogy of a mythological three-headed serpent came to my mind. I recalled my childhood and the tales I have read about such creatures. The biggest problem this serpent had, was: which of the heads was the master?
In our book ‘Make Data Work for You’ (which you can download for FREE here), we have presented the model of: ‘data – business planning – tools & techniques’, which seems to have a straightforward connection, and relevance to Prophix’s Insight 7. This model is also a similar legendary creature with three powerful heads and the same eternal dispute: which of the three is most important?
First of all, let’s have to look at each ‘head’ separately.
The Prophix survey states that ‘Companies face a shortage of the right data’ (Insight 4). My first question is: what is the ‘right’ data? You get data from almost every department of your company, as well as from the outside world. The key to ‘right’ data is ensuring that the data you process and exchange fits the predefined purpose. In order for this to work, you and your colleagues and partners need to ‘speak the same language’. You need to be very meticulous formulating correctly which data you need and knowing which data you must get.
The next issue is the quality of the data. If you use ‘bad’ data for your analysis, it will directly influence the quality of your results. As they say: ‘Garbage in, garbage out’. How to get correct data that fits the purpose, at the right place, at the right time? You need to initiate the process of managing data according to the needs and feasible resources of your company. This can all be achieved with a well-implemented data management function.
Now assume you have right data at the right place. Is your FP&A function mature enough to process the data effectively? Accordin to the Prophix survey: ‘Companies invest time on the wrong FP&A activities’ (Insight 3), ‘FP&A teams aspire to be more strategic (Insight 2), ‘Companies are immature relative to FP&A analytics’ (Insight 1). In order to become more mature and strategic, you need to know which of your business stakeholders have which needs and information requirements. You need deliver information that fits the decision makers’ purposes. And the delivery of this information needs to be as effective as possible. So, business partnering and optimization of your own processes, together with business planning methodologies call to action. You need to move from data processing to data and information analysis. You need to move from looking back to looking forward in your analysis. By providing correct advice to decision makes you gain the position of a strategic partner.
The efficiency and effectiveness of business planning processes and advanced techniques often require the support of modern technology. Quoting the Prophix survey again: ‘FP&A success is inhibited by technological immaturity’ (Insight 5). Here is the time to assess which technology meet your real business requirements and fit your company capabilities. From my experience, very often after implementation of software applications, only 20 % of the functionalities are used. Why? Perhaps due to limited knowledge, absence of trained staff, and thus not knowing, or not having the means to use the software to its full potential. Manual work-arounds are built as substitution for these limitations. The real key to solving this issues is matching your technological ambitions with your real needs and capabilities.
Now let’s get back to our FP&A serpent. I believe its three heads are three masters that cannot be separated from each other. Each head plays own important role in FP&A development. They do need to be working together to a set purpose, and correspond to the company’s resources and ambitions. Only then they can conquer the world.
The next, and more important question is: in which order should you start improving the 3 key elements in order to work on your own FP&A (r)evolution?
The FP&A function has certainly evolved from a tactical to a more strategic function over the past five years. A perception that has become relatively common is that most FP&A teams have the resources and support they need to deliver meaningful strategic value. I partnered with FP&A thought leaders Larysa Melnychuk, and James Myers to develop the FP&A Empowerment: The Evolution of Technology & Trends survey in part to find out if this perception is a reality. Are FP&A teams empowered to deliver strategic value across the enterprise?
The results of the FP&A Empowerment: The Evolution of Technology & Trends survey indicate levels of data, analytical, and technological immaturity that make me lean towards classifying this perception as a myth. The survey results were so surprising that I used polling questions in two FP&A focused webinars in Q4 of 2018 to support for the results or to offer caution in making inferences based on the survey results.
In terms of data maturity, the struggles of the FP&A Empowerment: The Evolution of Technology & Trends survey respondents are depicted in the chart on the left side of Figure 1 below. Eighty-eight percent (88%) of companies struggle with data availability and quality as only twelve percent (12%) of respondents have access to the right data in a timely manner. The data maturity of companies attending FP&A focused thought leadership webinars in Q4 of 2017 is not any better. Only 11% of the 183 of webinar attendees answering a polling question relative to the data maturity at their companies reported that decision makers have access to the right data at the right time, data nirvana. The webinar company sample has even more prevalence of data overload at 21% versus 10% for the FP&A empowerment company sample. The data from the webinar polling questions does not contradict the general level of data immaturity at companies evident in the results of the FP&A Empowerment: The Evolution of Technology & Trends survey.
A survey question designed to help assess the technological maturity of companies taking the FP&A Empowerment: The Evolution of Technology & Trends survey was: How modern are your company's reporting and analytics tools? The surprising preponderance of technological immaturity at the companies of survey respondents is depicted in the chart on the left side of Figure 2 below. Forty percent (40%) of companies are leveraging only a basic (22%) or very basic solution (18%). Companies answering the same question posed as a webinar polling question also have a prevalence of technological immaturity (depicted in the chart on the right side of Figure 2 below). Forty percent (47%) of companies are leveraging only a basic (24%) or very basic solution (23%).
In assessing the level of analytical maturity of companies responding to FP&A Empowerment: The Evolution of Technology & Trends survey and FP&A webinar polling questions we leveraged the FP&A Analytics Maturity Model developed by the International FP&A Board depicted in Figure 3 below.
The surprising degree of analytical immaturity at companies represented in the results of FP&A Empowerment: The Evolution of Technology & Trends survey is depicted in the chart on the left side of Figure 4 below. Fifty-five percent (55%) of companies reported being in a developing state, basic (13% or developing (42%). Furthermore, only 17% of companies reported being in a leading state of analytical maturity, advanced (14%) or leading (3%). The general level of analytical maturity of companies attending FP&A focused thought leadership webinars in Q4 of 2017 (depicted in the chart on the right side of Figure 4.) is not any more encouraging than that of survey respondents. Sixty-three percent (63%) of companies reported being in a developing state, basic (15%) or developing (48%).
Most FP&A teams are empowered to deliver strategic value across the enterprise, perception or reality? Unfortunately, based on data obtained from over 500 companies across the globe, it appears to be much more perception than reality. Data immaturity, technological immaturity, and/or analytical immaturity are inherent barriers for companies in realizing the potential that the FP&A function has to offer in empowering data-driven decision making that improves performance across the enterprise.
If you want to learn more:
By Randall Bolten, longtime Silicon Valley CFO, author of "Painting with Numbers: Presenting Financials and Other Numbers So People Will Understand You,” and adjunct professor at U.C. Berkeley Extension
Well-designed incentive compensation plans – especially sales commission plans – are an incredibly powerful way to motivate great performance. But designing a great plan is both an art and a science, and prone to design mistakes that are expensive and end up not motivating the desired performance. The commonest and most serious error plan designers make is to lay out the rules before deciding just what it is the enterprise is trying to accomplish. You can avoid that mistake with a simple, straightforward graph that I’ve drawn hundreds of times in my career. Follow these steps:
1. Draw your axes. “Performance” goes on the X-axis (i.e., the horizontal axis) and “Compensation” goes on the Y-axis (i.e., the vertical axis). For now, you don’t have to graph actual dollar amounts… just think in terms of percentage of target amounts:
2. Plot the obvious points. Those would be 0% of target comp at 0% of target performance and 100% of comp at 100% performance. You might also find it useful to draw a reference line through those two points. (That reference line happens to be the graph for a plan with a commission rate that is constant across all levels of performance.)
3. Plot some additional points and connect those points with straight lines or curves. Work with line managers and senior managers to get a sense of how much incentive comp they believe is appropriate at specific levels of performance. For example, here’s a graph for an “accelerated” sales commission plan – that is, one where above-quota performance is rewarded with increasing commission rates, and below-quota performance is penalized, where management has specifically suggested compensation of 40%, 165%, and 250% of target comp for performance at 50%, 150%, and 200% of target, respectively. Note that the compensation curve sits below the reference line for performance below 100% of target, and above the reference line for performance above 100% of target:
4. Plot the same graph, but this time with actual performance levels and comp amounts. Here’s what the graph might look like for the accelerated plan described above, where “Performance” is Sales, with a quota of $2,000,000, and target commission is $100,000:
You’re now ready to flesh out the comp plan with spreadsheets and other formal documentation.
Just for comparison, here’s another example, this time for a typical management MBO plan where no bonus is earned until a specific performance level, such as 60%, is met, and the maximum bonus is the target MBO amount:
In this way, you can visualize any approach to incentive comp, form conclusions about whether that’s the approach you want, and then fill in the blanks to design a comp plan that actually does what you intended.
Sometimes a picture IS worth 1,000 words.
RANDALL BOLTEN grew up in Washington, D.C., the son of a CIA intelligence officer and a history professor. He is passionate about the importance of presenting financials and other numerical information in a cogent and effective way, and in his current life is the author of Painting with Numbers: Presenting Financials and Other Numbers So People Will Understand You (John Wiley & Sons, 2012).
He is a seasoned financial executive, with many years directing the financial and other operations of high-technology companies. His experience includes nearly twenty years as a chief financial officer of software companies.
He has held the CFO position at public companies BroadVision and Phoenix Technologies, and at private companies including Arcot Systems, BioCAD, and Teknekron. Before his CFO positions, he held senior financial management positions at Oracle and Tandem Computers.
He received his AB from Princeton University, headed west to earn an MBA at Stanford University, and ended up staying in Silicon Valley.
In addition to writing Painting with Numbers, he currently operates Lucidity, a consulting and executive coaching practice focused on organizing and presenting complex financial information. He divides his work time between Glenbrook, NV and Washington, DC, and maintains an office in Menlo Park, CA.
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