How FP&A takes the CFO to school and adds strategic value

By Timo Wienefoet, Managing Partner at IMPLEXA GmbH

The dusk of Management Taylorism is the dawn for the strategic CxO. Constant cooperation, communication and deep business process knowledge are the answer to digitalization, data lakes and disruptive threats. The opportunity for Finance is to extend resource allocation and financial planning towards becoming the trusted strategic advisor beyond the mere financials. How can FP&A support this achievement? 

BY TAKING THE CFO BACK TO SCHOOL!

Mintzberg, Ahlstrand and Lampel go on a strategy safari and present the historic schools of strategy. Each school has a distinctive focus and their combination put the corporate strategy beast to live. There are there main classes that shape the decision-making of future profitability:

The Prescriptive Schools of Strategy 

1.    The Design School
2.    The Planning School
3.    The Analytical Positioning School

Designing a conceptual framework for strategy formulation, developing an organizational planning process and enhancing it with an analytical positioning in the marketplace dominated the literature from the 60s to the 80s. Financial Planning & Analysis is by its very name a kid of these decades. A visual sneak into the "Technology of the 80s" makes it obvious why FP&A can't stop there. Yet, these schools are the compulsory exercise for the CFO with the following six schools to be considered the free skate event. 


 

Challenge the CxO league in all strategic schools!

The Descriptive Schools of Strategy
4.    The Entrepreneurial School
5.    The Cognitive School
6.    The Learning School
7.    The Power School
8.    The Cultural School
9.    The Environmental School

 
Moving from the foundation schools about strategy to the field exercise, entrepreneurs envision products and put them to live. This strain is a prerequisite to formulating a strategy to be a cognitive process deriving from individual brain activity and psychology. The Cognitive School is small yet powerful with Daniel Kahnemann and Edgar Schein contributing as psychologists to the strategist's mind. Btw, Eric Kandel, like Kahnemann also a Nobel laureate, wrote a tremendous book on the brain, perception and learning. 

"Culture determines and limits strategy!" Edgar Schein, MIT (pdf Review here
 
Taking a perspective beyond the individual are the latter four schools. Learning is equal to an emerging strategy as the complexity of the world is neither grasped in a moment nor steady enough for a once for all determination of the business future. The schools set a strong argument for a frequent planning and forecasting process facilitated by FP&A.

 
 

The Power School implies strategy as a result of negotiation and compromise. In this fpa-trends article, I laid out the negative effects of a group decision: the compromise tends to be loaded with risk. This being the most cooperative and communicative school, the CFO is well advised to cross borders into knowledge about the process of political decision-making (the german standard at google books). This holds true, esp. as the traditional, military styled organization makes room for more cooperative and communicative forms. The democratic design of special forces worldwide proofs, that the military again leads the way.

While the schools from 1 to 8 take an active stance, the Environmental School is a reactive school with a strategy derived from external forces. The CFO can manifest it in comparative KPIs and benchmarks. Being blind on this side, strategic actions will flow around Finance.
 
Look at the competition and express their performance to underline the strategic ambitions of the company!

Combinative and transformative:

10.    The Configuration School
combines any selection of the empirical and theoretical findings clustered in the schools above. Here, why can't Finance hold the grail to a strategically shaped future with a 

  • solution-driven culture, 
  • close communication and cooperation,
  • solid business processes and
  • fit incentive systems

as laid out by the International FP&A Board? There may be a few personal related ones which bring us back to the beginning: back to School, learning never ends!

Accessible FP&A

By Karl Kern, Founder/President, Kern Analytics LLC

A purpose of FP&A is to help people acquire insight into how organizations function.  People acquire insight from a variety of sources; they can acquire insight by reading reports, talking to people, or walking through facilities.  A reason people choose a certain source to acquire insight is accessibility and as a result FP&A practitioners should make their insight accessible.

Technology has created significant changes in our ability to acquire access.  Hardware like smartphones and tablets makes it easier for us to receive as well as send information.  Software is no longer constrained to desktops and laptops; software can be stored on servers that allow us to record as well as obtain information.  Perhaps the greatest change due to technology is the internet.  The internet has transformed our ability to acquire access.  Changes in our ability to acquire access will no doubt continue.  The elements of FP&A, planning and analysis, should welcome these changes as a way to enhance its role within organizations.

Accessibility within financial planning can be achieved in a number of ways.  Using shared document software like Dropbox and Google Docs can allow people to review as well as update elements within financial plans.  Using communication software like Skype can allow people to engage in the financial planning process regardless of physical location.  Using cloud accounting software like QuickBooks Online and Xero can allow people to evaluate budgets wherever they are.  The internet serves as a valuable resource for support reference class forecasting.  Reference class forecasting is an important part of the financial planning process dues to its ability to minimize the effect of optimism within financial plans.  These are only examples; one’s education and experience can discover additional ways to develop accessible financial planning.

Accessibility within financial analysis can be achieved in a number of ways.  The internet acts as a library containing volumes of information.  These volumes provide insight into the profitability, liquidity, and solvency of companies as well as industries.  Cloud accounting software provides statistics that can be obtained by people wherever they are.  Smartphones and tablets can be used to obtain statistics in a manner that reduces the burden of using desktops or laptop.  Financial analysis is a process that helps people learn how organizations function.  Learning how organizations function should be made as accessible as possible in order to improve the well-being of not only the organization but also its stakeholders.

FP&A is an important part of an organization.  Thinking about how an organization will function and learning about how an organization functions are tasks that help an organization move closer to its goals. Accessible FP&A is and will continue to be a part of a commitment to continuous improvement.  

The Concept of ‘Beyond Budgeting’

The concept of ‘Beyond Budgeting’ has been around for nearly twenty years now. Although it has helped transform many businesses and has become part of mainstream management thinking in some parts of the world, I talk to many business people who have still not heard of Beyond Budgeting. And many of those that are aware of it find the concepts difficult to grasp.

I believe that these ideas are too important to be overlooked or ignored – so I wrote a short book to fill these gaps in awareness and understanding.

The name of the organisation itself gives some clue as to why these gaps exist. ‘Beyond Budgeting’ (BB) describes what it wants to get rid of but not what should take its place. And the alternative that it advocates is not a simple blueprint that can be copied and rolled out across an organisation. Rather BB is a set of principles that have to be interpreted in the context of the unique challenges and opportunities faced by any particular organisation

For finance professionals, Beyond Budgeting changes how they do things not what they do.

So, instead of setting fixed targets for the end of the financial year, they would set relative targets that do not expire at period ends. And forecasting across a rolling horizon would replace detailed annual plans.
Resource allocation is a continuous process, made in response to emerging threats and opportunities, rather than an annual set piece event. And performance is measured by tracking trends rather than analyzing variances to budget.

Finally, the elimination of fixed annual budgets also has implications for other, related, business processes, such as how incentives are set and business activities co-ordinated.

If BB sounds like a small idea, of interest only to the Finance community, think again. But in reality, it is a large and subtle set of concepts that have important implications for the way that work is done and how organisations are structured and governed. To use an analogy from computing, BB looks like an organisational ‘app’ but it is more like an operating system - largely hidden from view but critically important to the functioning of the entire system and how it performs for its users: its employees, customers, suppliers and shareholders.

Beyond Budgeting creates an opportunity for finance professionals to contribute to business decisions making in a positive way rather than being the guardian of a process that everybody hates and adds so little to the business. I see BB as being liberating for the business and for the people working in it - finance people included.
 

 

Two Points At Which Controllership And FP&A Diverge

By Emmanuel Jibodu, Sr. Analyst, Global Finance - Stericycle Inc.

The inspiration for this article stems from a recent conversation on a Financial Planning & Analysis (FP&A) LinkedIn group that I'm a member of. A highly regarded FP&A professional posited that we discuss the differences between the controllership function and FP&A. This post will highlight a couple of differences from an FP&A practitioner's perspective.

CFOs, historically, cut their teeth in Controllership, FP&A, and Treasury before their ascension to the CFO role. Today, in most large corporations, the controllership function and FP&A have been bifurcated; they operate as two separate teams and have different mandates. The controllership function, nowadays, reports to the Chief Accounting Officer, while the FP&A function reports to the Chief Financial Officer (CFO). Itemized below are 2 main differences between Controllership and FP&A you will notice in the Office of Finance for most world-class organizations.

1. Ethos

•    Historical vs. Forward Looking
•    Compliance vs. Exploratory
•    Cost Control vs. Top Line Growth

2. Data 

 

1. Ethos

The guiding principles of Controllership and FP&A functions can be subdivided into three categories:

Historical vs. Forward Looking

Controllership involves the accurate preparation of financial statements based on past periodic, quarterly, and annual financial performance. Financial reports are used by senior leadership to evaluate the performance of an enterprise or business unit. Investors use financial statements to gauge the performance of senior executives and whether the strategy adopted by a company's C-suite is successful. Creditors use financial statements to determine whether an enterprise can take on additional financing or has violated debt covenants.

Although the FP&A function sometimes gets involved in the historical analysis and reporting of trends in key performance indicators (KPIs), the bread and butter of FP&A work are predictive. FP&A offers senior leaders insight into the future financial position of an organization; this is done by leveraging statistical/data analysis - for example, multiple regression, moving average methods, what-if analysis, etc., performance indicators, macroeconomic indicators, and business intelligence systems to forecast the operational and financial performance of an enterprise. The forecasts FP&A teams provide senior leaders help guide: (a) resource allocation such as personnel, capital allocations, and investments (b) the rarefied circles of Wall Street and manage "street expectations."

Compliance vs. Exploratory

Financial statements must be in compliance with tax laws, IFRS, US GAAP, Sarbanes-Oxley (SOX). The remit of the controllership function is to capture the economic reality of the company's performance to the last cent (or dollar). When capturing items such as depreciation, amortization, impairment, pension obligations, revenue, leases, research & development costs, the controllership function cannot deviate from the guidelines or rules that IFRS or US GAAP provide them.

There are certainly best practices that are adopted by most FP&A teams, however, FP&A practitioners can explore different analytics methodologies and procedures for their assignments in the areas of planning, forecasting, budgeting, and ad hoc analytics. For example, there are a couple of methods an FP&A professional can deploy when tasked with forecasting sales for a software company. Traditionally, software companies have significant forecasting risk due to their inherent high operating leverage, as a result of their significant personnel costs. To forecast revenues for the next 5 quarters, he or she could analyze the number of request for proposals (RFPs) submitted per quarter per line of business (licenses, consulting), by product line, by geography, by target market (government, health care), - then this metric is forecasted for next 5 quarters. See formulas below to determine: New License Revenues per quarter.

Hence, he or she has to explore several dimensions during the course of the analysis. It would also be prudent for FP&A to model different scenarios for the sales forecast. For example, competitive pressures could cause the company to lower prices on their products and services - causing the average dollar amount per deal to decrease in future quarters. Alternatively, to produce a sales forecast, the FP&A professional can use historical data to forecast total sales using an exponential smoothing model.

Cost Control vs. Top Line Growth

An FP&A function that does not deliver financial insights that lead to enterprise sales growth is likely not delivering the return on investment (ROI) that senior leadership expects. Sales growth, among other financial indicators, is a sign that Wall Street examines when analyzing a company's performance. I imagine the conversation between a Controller and an FP&A Director at a cocktail event would go something like this:


FP&A Director: Hi... What a great event, isn't it...How was your year, at work?
Controller: Excellent! Our team saved the company a lot of money...by controlling our expenses in admin...and direct costs as well. Our expenses came under budget for the first time in 3 years... How was your year?
FP&A Director: We had a great year as well. We provided the CFO with insight into a market entry opportunity for our company... by acquiring the #3 company in Europe for our industry. We are expecting this deal to be accretive to Cash earnings per share (EPS)...by at least 12.3% over the next 3 years...Importantly, we're anticipating revenue synergies that will enable us to be the #2 company in our industry in the next 2-4 years...in terms of global market share.

2. Data

The Controllership function mainly uses internal financial data that stems from Enterprise Resource Planning systems (ERP) to accomplish their objectives. Journal entries are posted to the General ledger system, the trial balance is prepared, adjusting entries are recorded (if needed), accounts are closed, and financial statements are prepared.

FP&A teams use both external and internal data to accomplish their objectives. For example, to develop a sales forecast for a software company whose clients are large corporations, FP&A would have to consider external macroeconomic indicators (i.e. leading indicators) that impact sales performance, as a variable. These indicators could be GDP growth and durable goods orders.

The Controllership and FP&A functions are two important components of any high performing organization, they have different mandates, however, they speak the same language, the language of numbers.
Comment below if you are a controller, member of an FP&A team, or treasurer and share your own professional experiences.

FP&A Analytics and Simpson’s Paradox

By Christian FOURNIER,  Retired Head of Finance Europe at Orange Business Services, Author (Globalisation - adapter l'organisation de son entreprise face à la mondialisation...)

Are your KPIs, Scoreboards and other metrics safe from the Simpson's paradox?

“Simpson’s paradox or Yule-Simpson effect is a paradox in probability and statistics, in which a trend appears in different groups of data but disappears or reverses when these groups are combined. It is sometimes given the descriptive title reversal paradox or amalgamation paradox”. (Extract from Wikipedia)

KPI, dashboard, other types of analytics,… that finance and FP&A use for communication may include or generate such paradox polluting the decision making process. Typically, those tools aggregate i.e. combine data in the perspective to give simpler and quicker ways to manage and communicate performance and take decisions. The general trend in management practices is to highly recommend limitation of indicators’ number, and as such to increase the aggregation level. It more or less focuses the attention of top and middle management depending on company culture and on rewards and recognition systems.

It is then highly possible for such aggregation to induce directly or indirectly “false” understanding or certitudes just like Simpson’s paradox would do. It should then be FP&A role to find and to fight such occurrence.

Still, we hardly hear or see mention of this concept during professional studies and life. 
Practically, teaching and promotion of such tools includes few recommendations that would potentially exclude dropping in that trap but without formally researching or verifying whether it exists or not.

Example

A sales director is looking at the ratio of commercial contact turned into sales in order to follow the performance of two teams and (among few other things) reward them on this basis. 

Team 2 had better rewards periods after periods.  

Frustrated Team 1 leader ask their FP&A to analyze in more details and feedback is 
“Sorry, Simpson paradox!! Here is a better view of the relative performance! In fact, the two teams had the same performance over last 6 periods“ 

Of course, here I forced the figures to a ridiculously simplistic example to illustrate my point and make it easy to understand. 

In real life, it is generally far more complex to identify such issue. My example is a reversal case (or nearly) which is more easy to spot. Still, in many cases it will not be so extreme, it will only hide (make disappear) the real evolution or performance. 

The paradox appears thanks to few main causes:

  1. Dependent variables are hidden through the aggregation of data,
  2. Difference of distribution in time (the example is it),
  3. Difference of size between the data groups entering in the calculation.

Similar examples can be found with return on investments, any given type of expenses (say marketing) versus revenues, product lines revenue distribution or growth, etc.… (In fact, many of the widely known ratios or indicators may very well include or generate such effects if not properly customized and tested).   

This brings few questions:

  1. Up to what point this paradox is known (as such or in another form)?
  2. How is it reflected in the definition and implementation of the company tools and processes?
  3. How is the verification done?

In my example, FP&A should have to make sure the KPI was not reduced (aggregated) to such a level and demonstrate that a more comprehensive set of figures needs to be considered, this should have been made during the set-up of the company systems and FP&A should have “tell the story” behind those figures all along the process in such a way that recognition should have been more in line with performance. A period to date indicator (or a weighted indicator) would have been more representative e.g.

In this example, it is highly intuitive, i.e. even without knowing about the paradox, a reasonably able person shall have made it happen. Still, reality can be far more complex and intuitive reasoning might not be sufficient to identify and adopt the right approach in each and every case, in particular, when the context is strongly oriented towards limiting the number of KPI, Indicators,… used by management. Who has not heard a manager saying “This is too much detail/figures, I just need to know (i.e. my compensation is only based on) these x indicators”. 

Obviously, this brings into picture a different subject i.e. the reward and recognition based on KPI, scoreboard and other metrics. Still, is it really different, if the metrics can reveal to be paradoxical?!

Knowing (be conscious of) this paradox and systematically making sure to avoid its trap is then a key role for FP&A (i) when elaborating the systems and process that will be used (ii) when analyzing and commenting the ongoing results. 
 
We may try to draw a list of a potential common case but it remains a high-level approach that cannot exempt from doing effectively the exercise. 

  • Volume vs price evolution i.e. where your Revenue Indicators may hide more or less important shift in the price and/or volumes. Similar for external expenditures.
  • Regional differences, RI covering wide geographic reach may hide major evolutions in the respective areas,
  • Customer profiles differences, RI covering wide customers profiles may hide customer profile shift,
  • Product or market maturity phase, RI covering wide range may hide product or market maturity shift,
  • Currency effect, in particular when pricing currency is different from the entities currency and from the consolidation currency. Indicators expressed in consolidation currency will aggregate and then hide any currency effects and shift. This also applies to most costs.
  • Risk assessment or indicators,
  • Quality indicators,
  • Productivity indicators, 

Those applicable to revenues (but not only) may very well combine all together. 

A very simple  example would be a global company management concentrating on an overall revenue indicator mixing revenues from different geographic areas with product and markets in different maturity phase where customer profiles are evolving rapidly and where business is done in few pricing currencies but over a large number of legal entities (with different currencies then) and consolidating their results in its home currency. Such a global revenue indicator would mix so many effects and potentials evolutions that it may reveal paradoxical. Even more dangerous, as it may not have been a problem for few years i.e. whereas the potential of an issue was there but the reality of the markets was not challenging (activating) it. 

We could bet in such a case that the information systems will “lose” the pricing currency within the consolidation process, potentially shortcut the entity currency to consolidation currency effect too; will aggregate the product into a few product lines historically driving the company development, will probably lose track of the customers profiles among few other “simplifications” justified by the necessity to keep things more effective. Furthermore, the FP&A people may be located in a limited number of shared service centers loosening the contact with local reality. The end result would be that the whole organization IS and processes, (probably culture) are cut from reality thanks to a basic misconception (lack of understanding/verification) during the process of defining and implementing tools.  

FP&A peoples do not need to know all the mathematics about this paradox. They still need to understand the concept, recognize that it may “slip in” when defining their tools and processes, KPI, Scoreboard and other metrics and then make sure it is not the case.  

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