Tuesday, 28 July 2009

Paralysis Without Analysis

This is the fifth in an 8-part series especially for new subscribers to the Creative Finance & Management email newsletter. Every week we are sending you an article aimed at helping you to think about a different aspect of the financial management of your business. This is in addition to the normal bi-weekly newsletter. We are doing it to give all new subscribers the same orientation to the way that Charis FD thinks about small business performance management. That way we can have confidence that all our subscribers have been given the benefit of foundational advice in all aspects of business performance management.

If you miss any of these articles, don't worry. They are on the Creative Finance & Management blog. Just look for the "New_Subscribers" tag.

These are the articles in the New Subscribers series:

1. The ingredients for success in Finance
2. Strategy and Planning
3. Business Change - implementing your strategic plans
4. Measurement and Management go together
5. Paralysis without analysis
6. Your Finance team - a valued asset
7. Stakeholder management - the importance of keeping people happy
8. Internal Control - 3 fallacies that add risk to your business

Here we go: ...

Paralysis without Analysis

Over the last three articles that we've sent to you as part of our new subscriber series we've covered the points around the outside of the business performance management wheel - strategy, change, and performance measurement/reporting. There is one more thing to talk about briefly before moving on to talk about the Finance function (next time) and then other key concerns such as risk, controls and stakeholders. That is performance analysis. I like to call it performance improvement analysis.

If you've read the previous articles in the series you will have picked up the philosophy underlying my advice - be intentional and analytical. Mostly, though, we've talked about being intentional - if you mean business, then you are intentional, you know where you want the business to get to and you know how you intend to get there. And you know whether you are making progress because you are intentional about measuring performance.

Now I want to talk about being analytical.

I started writing something a bit philosophical here at first, and then I heard myself yawn! So I deleted that. Do you want to get under the skin of the performance of your business? Do you see things that are happening and wonder why? Do you wonder which of your products is really the best? Is it the one that sells the most? Do you wonder which of your customers is really the most important? Is it the one that buys the most?

Analysis is all about asking "why?" And "what if?" It can be as basic as "why have we made a loss this month?" Or it could be more complex, such as, "what if we offered early payment discounts of x%?" Or even more complex, like, "what if we paid £xmillion to buy a business?"

It doesn't have to be financial data. Other numerical analysis is useful too. In fact, if you can make it numerical or financial then it is often easier to get a qualitative understanding of the issue - i.e. is it good, bad or ok. One example of numerical analysis that I dealt with in one large group was looking at absenteeism. How many days of work did we lose through sickness? And in which locations? Which teams? Was it seasonal? Was it improving or getting worse? You may be asking, "where is the why question in that?" Well, think about, "why are our staff costs so high?" There are accepted benchmarks around, so we could tell whether the sickness absence rates were better or worse than the average for those types of people. That enabled us to focus on particular areas, ask further questions and put actions in place to improve. Reducing absenteeism eventually led to lower staff costs, because we didn't need as many people to do the work. That's another example of what we saw last time - that measurement enables you to manage and therefore improve.

Analysis enables you to drill right down to cause and effect relationships. The idea is that if you can measure and manage those cause and effect relationships then you can reduce things that drag the business down and enhance things that positively influence the business.

Many big businesses suffer from what they call, "analysis paralysis", which basically means they have gone too far. They have analysed everything and now have so much information that they can't make sense of any of it. Smaller businesses very often suffer from the reverse - "paralysis from lack of analysis"! Have a think about what information you have available in your business. How well do you really understand the cause and effect relationships?

But where do you start? Here's my suggestion: Take a key performance measure, one with strategic importance, and ask, "what would I have to do to make it better?" There may be several things you could do. Get information on what the current situation is for each of them. Then for each of those things, ask, "what would I have to do to make that better?" And keep on going through that cycle until you feel you have got somewhere close to root causes. Along the way you will have analysed your business performance and got valuable insight into the things you have to do to improve.

Here's an example: Let's say that in my business, staff costs represent 70% of the cost base. What would I have to do to make that better? Reduce headcount or reduce remuneration. Let's discount the latter for now. So we should analyse how our headcount is made up - by department, by grade, by location, etc. What would we have to do to reduce headcount in each of those categories? Reduce work or become more efficient. So let's analyse what work the people are doing and how efficient are they - what do they produce and how many do they produce per day, hour, week, month, whatever is appropriate? So with that information, what do we have to do to reduce work? Stop doing certain things - so what would be the impact? And what do we have to do to become more efficient? Do things quicker. So in order to see which things we need to do quicker, we need to analyse what activities have to be done to produce the outcome and how long each activity takes. Then we can look at the main activities and ask for each of them... you've guessed it! "What would we have to do to make that better (or quicker)?"

So to conclude, in order to manage business performance you need to measure it first. But you need to do more than that. You need to understand what the figures are telling you. And in order to understand, you need to analyse - financially, numerically and logically.

But one final word of caution - only measure things that are useful and you can act upon. If you find yourself regularly looking at figures that you do nothing with, then ask yourself what they are for... and if you can't find a satisfactory answer, STOP producing them and go and find some more useful analysis to look at!

In the next newsletter for new subscribers we'll look at your Finance resources - people, systems and processes. Are you getting the best out of them?

Until then, take care...

If at any stage you want to talk to us, we're quite happy to give you a call to talk more about your business and the challenges you face. And you may be eligible for a free Finance Strategy Review session. To set that up either email us at enquiries@charisfd.com, remembering to leave your phone number and email address; or go to our website and complete the contact form.

Thanks again for subscribing to Creative Finance & Management. We hope you find it helpful.

Monday, 27 July 2009

Measurement and Management go Together

This is the fourth in an 8-part series especially for new subscribers to the Creative Finance & Management email newsletter. Every week we are sending you an article aimed at helping you to think about a different aspect of the financial management of your business. This is in addition to the normal bi-weekly newsletter. We are doing it to give all new subscribers the same orientation to the way that Charis FD thinks about small business performance management. That way we can have confidence that all our subscribers have been given the benefit of foundational advice in all aspects of business performance management.

If you miss any of these articles, don't worry. They are on the Creative Finance & Management blog. Just look for the "New_Subscribers" tag.

These are the articles in the New Subscribers series:

Measurement and Management go Together

"What gets measured gets done!" is often quoted as a truism. The other way I would put it is, "if you don't measure it, you don't manage it". What I want to do in this article is show you the principles of how to apply that to managing the performance of your business. You do want to manage the performance of your business, don't you? You know that if you don't manage performance then your business will almost certainly underperform?

I've tried to say in the last three new subscriber newsletters that you have to be intentional in managing business performance, or in managing a business in general. If you want your business to perform well, you have to know and specify what you want it to achieve and have defined strategies for achieving those goals. You should also have given yourself targets for what each of your strategies should achieve.

But you can do all that and still not succeed. One of the main reasons that happens in smaller businesses is that they don't check regularly to see whether they are succeeding or not. They don't measure the outcome of their strategies, or at least not regularly enough. It's no use getting to the end of the year when the auditors come in, or when you sit down with your accountant, to find out that you haven't grown your business as much as you wanted to, or you spent too much. It's a bit late then. You need to measure outcomes monthly, weekly, and daily in some cases.

Getting into the nitty gritty for a minute, the basic financial performance reports you need to have on a monthly basis are the income statement (or "profit and loss account") and the balance sheet.

The income statement should not be in so much detail that you can't see the wood for the trees, but should be in enough detail to see where your money is coming from and where it is going to. For example, if you sell the same small set of products to a few regular customers, then show your income by customer or customer group. On the other hand if you have a varied product set you may want to show your income by product. This depends what your marketing and sales strategies are - segment your income in the same way you segment your sales for strategy purposes. Then you can see if your strategy is making any difference.

Similarly you will want to show your costs in the income statement in a way that makes sense. You may show them by type (e.g. premises, people, insurance, IT, etc) or by department (e.g. operations, sales, finance, IT, HR, etc) or both. It depends how complex your department structure is and how you manage your business.

The balance sheet shows the value of what the business owns, what it owes and what it is owed. It is useful to see particularly the cash balance, the debtors balance (what your customers owe you) and the creditors balance (what you owe suppliers).

But this is just the basic level. Every business should do those without question. You need more. If your strategy is targeting increasing sales, then you must also get more detailed reports on sales. If your sales cycle is less than a month, then perhaps you should be getting sales reports weekly or daily. If your strategy depends on production quantities and operational efficiency, then perhaps you need daily or weekly reports on those things.

And again, don't just look at financial performance. Performance measurement and management are much broader than that. If you are a service business, perhaps you need to measure that utilisation ratios for your consultants (time spent generating revenue divided by time available). If you have a long sales cycle, perhaps you need to get weekly or monthly reports on leads generated and sales pipeline reports. If these things are critical in your strategy to achieve your vision for the business, then you can't manage them properly without measuring how you are doing.

To sum up, what are the key things to think about in performance measurement and reporting? What, how and how often - those are the three key questions. What to measure will depend on your strategy, the things you are doing that are important to getting the business towards achieving its vision. How to measure it will have to be thought through carefully - it could be a figure, a ratio, a traffic light, a pie chart, etc. How often will depend on how often things change. You want to be able to make decisions and adjust your strategy and tactics on the basis of what the information is telling you, so the information has to be timely.

Finally, all this measurement will be worth nothing if you don't use it, if you don't make decisions based on the information. No strategy is perfectly infallible. The information you get may tell you that you are not quite getting it right. If you are learning from the reports you get, you will investigate further and tweak or change your strategy depending on what you find. This the feedback loop complete. The business performance management wheel that I talked about in the first of these articles depends on completing the whole cycle - develop your strategy, carry out your strategy, measure your performance and learn from the information to develop your strategy... and so it goes on.

I'm worried that this all sounds complicated, because I've condensed so much into a short space. If you do a healthcheck on what you actually do at the moment, I think you will find that you already do some of this, but it may be ad hoc, disjointed and disorganised. As with other areas, putting some thought into it and having a rationale for measuring things about your business will get you a long way forward. Just the act of being intentional about performance measurement is big progress.

The final thing I would say is that this is probably one of the areas that someone like a Finance Director would add the most value. They are skilled in pulling numbers together and in interpreting what they mean for the business. If you haven't got anyone like that in your business, then give it some thought. And it doesn't have to be full-time headcount. There are part-time options available, which are more affordable for smaller businesses - one of these options is Charis FD's own services. That's a gentle plug for my business, but I think it's appropriate. See our website for more details.

If you are worried about the cost of such a service or the cost of taking on a full-time FD, think of it in terms of the financial benefits it could bring. They would work alongside you, helping you to put in place the finance and performance management disciplines we have been outlining over the last few weeks. So I would be surprised if following all this advice with help could not help to improve your sales by more than 5%, or improve your gross margins by more than 5-10%, or your net profits by 10% - especially if you have not employed one before (either full-time or part-time). If you look at it that way, it doesn't seem so expensive. That's obviously not making any promises, but it's food for thought!

Why not contact us today?

Until next time...

Thanks again for subscribing to Creative Finance & Management. We hope you find it helpful.

Business Change

This is the third in an 8-part series especially for new subscribers to the Creative Finance & Management email newsletter. Every week we are sending you an article aimed at helping you to think about a different aspect of the financial management of your business. This is in addition to the normal bi-weekly newsletter. We are doing it to give all new subscribers the same orientation to the way that Charis FD thinks about small business performance management. That way we can have confidence that all our subscribers have been given the benefit of foundational advice in all aspects of business performance management.

If you miss any of these articles, don't worry. They are on the Creative Finance & Management blog. Just look for the "New_Subscribers" tag.

These are the articles in the New Subscribers series:

Business Change

One of the areas where Finance professionals can probably add the most value is around business change. They bring control and ensure that you go into the change with your eyes open, and hopefully if you listen to their advice they can help to ensure you only implement changes that will benefit the business.

First let's start by defining "business change". Thinking back to the last new subscriber newsletter, business change is just a type of strategy for the business. Business change is simply changing the business in a big way. Strictly, I suppose, you could apply everything we are going to say to small changes (recruiting an extra person or buying a new PC) as well as big changes. But normally when we talk about business change we are talking about something that has a big impact. So it could be the acquisition of a new business, the introduction of some automation into the manufacturing process, the implementation of IVR on the phone system, buying a building, implementing a new accounting system, selling part of the business, restructuring programmes, closing a factory, opening a new shop, and the list could go on.

My point about business change is somewhat similar to my point about strategy last time - I can't stress enough the importance of being intentional and analytical. You may laugh at me at this point and say, "how can I buy a business or implement a new system without being intentional? I can't imagine ever saying, 'Oops! I accidentally just bought a business!'" Well, that's not exactly the point I'm trying to make.

The point about being intentional is because sometimes people suggest changes because they just feel like a change. It happens in both big and small companies. In big companies, the CEO might say, "I think we need an SAP ERP system, or a Siebel CRM system." In small companies, the owner may say, "I just feel that we need some really nice offices." Now in both cases there could be good reasons for wanting those things, but I've shown them bluntly to illustrate that it is perfectly possible that it's all down to vanity! The big company CEO may want to get those words on his CV, the small company owner may just want to feel more successful.

In one business I worked with I once heard an acquisition referred to as, "a triumph of vanity over sanity!" That was because the company paid too much to buy the business, so that it would take years to make a positive return on investment, but everyone had to admit that it looked good for the chairman/CEO, who was also the majority shareholder. If your business vision is to build your ego, rather than your business value and bottom line, then that type of acquisition is fine! That might sound sarcastic, but I'm actually being semi-serious. If you realise that a change project is not going to deliver any benefit to the business, but you want to do it anyway because you want the Kudos, then at least you are going into it with your eyes open. The people I have a problem with are those who try to fool themselves and everyone else that their project is really beneficial.

Ok, so what is the right approach?

Being intentional is about making strong links between what you are trying to achieve in your strategy and vision and the change you are proposing to make. The best way to do this is to write down benefits statements briefly in bullet points in the format, "one of our strategic issues is "; This project "; The benefit is ". If the benefit does not address a strategic issue, then why are you doing it? If your project is really addressing strategic issues in your business, then you will have no trouble writing down these benefits statements. If you do struggle then that should ring alarm bells.

Being analytical is objectively assessing whether the benefits will outweigh the costs. Sometimes this is where the frustration comes, when you discover that something you want to do is actually going to financial damage the business. The project may have so many benefits, but not enough to justify the cost and the impact on the bottom line. I admit it is frustrating. But it's better to identify this before you start, then you won't waste your time as well as your money!

As an example, I once worked with a very large company with nearly 40,000 employees. For two years the HR Services team had been managing annual bonus and pay review calculations through a suite of spreadsheets, while at the same time the business had been recruiting more and more people onto new contracts with bonuses. So their problem was only going to get worse. What the team proposed was an expensive off-the-shelf system. It would definitely save time and therefore money (not having to employ temps to do the spreadsheets), and reduce the risk of error, but when we analysed it the savings did not outweigh the costs, even over a 5-year period.

In that case I had to say no to them, but I also suggested that they talk to the IT team to see if they could write some visual basic to automate their spreadsheets. It wasn't the nice shiny built-for-purpose system they wanted, but since it was a fifth of the cost of the initial proposal it clearly then gave the benefits we needed at a cost we could afford.

Lots more could be said, but let's leave those things for future CF&M articles! In conclusion, be intentional - be really clear that the change you are proposing is addressing the biggest strategic issues you have identified. Also, be analytical and objective or realistic - set figures on the benefits and the costs and see if one outweighs the other over a period of time (say, five years).

Final word, just in case you haven't come across the term before - the benefits statements, and the analysis, are the main parts of what is normally referred to as a "business case".

All the best!

Until next time...

Thanks again for subscribing to Creative Finance & Management. We hope you find it helpful.

Strategy and Planning in Business

This is the second in an 8-part series especially for new subscribers to the Creative Finance & Management email newsletter. Every week we are sending you an article aimed at helping you to think about a different aspect of the financial management of your business. This is in addition to the normal bi-weekly newsletter. We are doing it to give all new subscribers the same orientation to the way that Charis FD thinks about small business performance management. That way we can have confidence that all our subscribers have been given the benefit of foundational advice in all aspects of business performance management.

If you miss any of these articles, don't worry. They are on the Creative Finance & Management blog. Just look for the "New_Subscribers" tag.

These are the articles in the New Subscribers series:

1. The ingredients for success in Finance
2. Strategy and Planning
3. Business Change - implementing your strategic plans
4. Measurement and Management go together
5. Paralysis without analysis
6. Your Finance team - a valued asset
7. Stakeholder management - the importance of keeping people happy
8. Internal Control - 3 fallacies that add risk to your business

So, ...

Strategy and Planning in Business
I guess the first thing you may be thinking is that you don't need fancy strategies in your business, because it's so small, so why should you bother with this article. Surely you just keep working hard and you'll make more money without going through pointless navel-gazing exercises to come up with strategies!? Well, I'd kind of agree with you that you don't need FANCY strategies, but in reality every business has strategies whether it consciously acknowledges them or not. So wouldn't it be better to choose those strategies intentionally than to drift into them?

It's all because the word "strategy" sounds a bit technical, something that generals do in wars when they have to organise lots of soldiers. It has connotations that sound big. But that need not be the case. Really a strategy is just a specified approach to overcome a problem or achieve an aspiration. And each strategy can have a number of activities within it that can be planned specifically.

So if you have a problem you want to overcome or an aspiration you want to achieve, then your approach to doing that will be your strategy. So you see that we all have strategies, even if your strategy to date has been to "wing it"!

One of my philosophies is that if you want to get anywhere with anything you have to be intentional and analytical. Being intentional is my point for now. For example, when I am trying to coach my son in how to get better at playing football I often tell him to be "intentional". In other words, don't just stand around on the pitch waiting for the ball to come your way, and when it does come your way don't just swing your foot at it and hope for the best! You must have a reason for being where you are, to gain an advantage for your team, and when you kick the ball you must know where you want it to go.

It's exactly the same with business strategy. You have to be intentional. And it doesn't have to be fancy and complex. Just have an intention. Because if you have an intention, it means you must have thought about it and have a reason for it.

Hopefully I've persuaded you that even if you have a small business you still need strategies. In the remaining space let's have a look at what you need to develop good strategies.

First, you need a "vision". A vision is simply a statement of where you want the business to get to. What's your dream for the business? How much profit? How much turnover? How big a valuation? Market share? Being number one? Even a one-man business has a dream. I know I do. But if you are going to be intentional you need to be specific about all the things you want the business to achieve.

Second, you need to know what the "strategic issues" are. Strategic issues are the barriers and challenges to be overcome or met in trying to achieve the vision. And to know what these are you have to be analytical. You have to gather facts and be honest about the market, the competition, your customers, your suppliers, the economy, and many other things. I know that small businesses often don't have the time and resources to gather all the information they would like, but mark my words, the more information you have the better equipped you will be.

Third, you need "strategies" to address the strategic issues. And to decide on strategies you may have several options to consider. Being clear about your vision and the strategic issues enables you to weigh up each option on its merits. Does this particular option address the issues completely or partially or not at all? Does it help with more than one strategic issue?

Fourth, each strategy needs a "plan". In order to successfully carry out a strategy you need to plan it, so that you know what needs to be done.

Last point - write it down and make a record of your vision and strategy. I wish I could remember where I heard this, but there was some research done on some graduates and whether they achieved their dreams. A much higher percentage of those who wrote down what they wanted to achieve did achieve their dreams. They had something to go back to and remind them what they were supposed to be focussing on, something to measure their performance against.

If you haven't ever thought of any of these things, why not have a go at jotting something down? Sure, there are coaches that can help you and courses, seminars and workshops that can give you more guidance and depth (and I would definitely recommend these things if you can afford them), but in my opinion you can get a long way by simply being intentional and analytical and ensuring that all your plans link through strategies to your vision.

All the best!

Until next time...

If at any stage you want to talk to us, we're quite happy to give you a call to talk more about your business and the challenges you face. And you may be eligible for a free Finance Strategy Review session. To set that up either email us at enquiries@charisfd.com, remembering to leave your phone number and email address; or go to our website and complete the contact form.

Thanks again for subscribing to Creative Finance & Management. We hope you find it helpful.

The Ingredients for Success in Finance

This is the first in an 8-part series especially for new subscribers to the Creative Finance & Management email newsletter. Every week we will send you an article aimed at helping you think about a different aspect of the financial management of your business. This is in addition to the normal bi-weekly newsletter.

Why are we doing this? Well it's certainly not because we want you to be overloaded with spam! This email is NOT spam. You received it because you consciously signed up to receive our Creative Finance & Management newsletter. But, hey, we know that even some newsletters you consciously sign up to might as well be spam!

So why are we intent on sending you twelve emails in the first two months of your subscription? The answer is that I looked at the newsletters that were queued to go out and tried to think what it would be like to simply start getting them at a random point. It would feel like pretty random subject matter, without a framework or rationale. And I felt that it would probably be useful to give all new subscribers the same orientation to the way that Charis FD thinks about small business performance management. That way we can have confidence that all our subscribers have been given the benefit of foundational advice in all aspects of business performance management.

If you miss any of these articles, don't worry. They are on the Creative Finance & Management blog. Just look for the "New_Subscribers" tag.

These are the articles in the New Subscribers series:

The ingredients for success in Finance

First of all, let's recognise at the outset that there are many things that can be said about making business successful. That's why I'm confident that I am unlikely to run out of subjects for the Creative Finance & Management newsletter! But after careful reflection on all that I've learnt over my 18-year career in accounting, finance and business, I believe that the financial and performance elements boil down to seven or eight things.

Now I admit that there are academics out there, as well as big management consulting firms, who have researched and pondered and discussed and head-scratched over many years, and they have written big books on topics such as these. And they have probably come up with other ways of looking at things, perhaps even better. Who knows? I am just someone who has looked at what I have learnt over the last 18 years, in my training, courses I've attended, as well as reflections on the work I've done, and pulled it all together in a coherent way.

So "take it or leave it" is what I'm saying. I have no desire to be seen as any kind of finance and management guru. I simply want to help small businesses do things better.

So what are the ingredients for financial success? All I am going to do in this article is lay out the scenario and describe the model. In the next seven articles I will explain the important parts of the model and how applying these principles can help your business to become financial stronger and more successful.

The way I look at it is like a wheel, with a hub, and a couple of other things. I call it the Business Performance Management Wheel. If you go to the Our Services page of the Charis FD website you will see this illustrated and described. There are four points around the outside of the wheel:

Strategy and Planning

Actions and Change

Performance

Performance Reporting and Review

Those elements are linked with a directional arrow, indicating that actions and change result from strategy and planning, and contribute to business performance. Then you have to review the performance of the business through regular reporting in order to feedback into more strategy and planning.

In the middle of the wheel is "Finance", which should probably be more specifically "Finance Resources". Finance resources keep the wheel turning, providing information and control.

Around the outside of the wheel are two elements:

Stakeholder management; and

Risk management and compliance.

Those are two things that provide the environment for business performance management.

I should also say that there are other dimensions. So cash/working capital is a dimension that has different implications depending on which of the elements you are thinking about. Profit is another dimension. And Performance is a generic term that includes profit, but does not exclude any measure of success in your business.

Over the next few weeks in these introductory newsletters we will take each of the seven elements in turn and outline what the key elements are in getting the business performance management wheel turning smoothly for you.

First, next week, we will look at strategy and planning. Where does strategy come from and how do you decide what your strategy should be? If you don't have strategies for your business and plans for achieving your strategic objectives, then you are leaving too much to chance and your business will underperform.

Second, we will discuss business change. Sometimes it feels like there are so many options for useful projects you could do, or things you could change, but you can't do everything all at once. So how do you know which of the options will be best to choose?

In the third week we see that measurement and management go together. If you want to be able to manage your finances, or your business performance in general, then you have to regularly review measures of performance. This is an area many small businesses need help with.

Fourthly, we talk about the "paralysis without analysis". A lot of big companies talk about "analysis paralysis", meaning they have so many figures, so much management information, so much analysis of figures, that they don't know how to digest it all. Smaller businesses are often paralysed by the opposite problem. They don't know what to analyse and have very little management information and modelling. What things are most useful? Where should you start?

Fifth, we'll talk about finance resources. Finance resources is the term I use to encompass finance and accounting people, as well as systems, processes (and perhaps even cash!). Your finance resources are there to support you in managing your business to optimum performance, providing information and control, as well as expert advice. So that fifth article will tell you more about what you should expect from finance resources and how to get the most out of them.

Sixthly, stakeholder management gets a mention. Stakeholders are anyone who has any interest in your business. Shareholders and investors are the people we normally think of first, but the list gets longer the more you think about it. There are a host of people and entities that should get your attention as stakeholders in the business, and good relationships with them will smooth the way for growth.

Finally, we snooze through 700 words on internal control. I'm joking! It's very important! But a lot of people see internal control as something boring and tedious. So we'll consider three fallacies that add risk to your business in the realm of internal control.

Until next time...

Thanks again for subscribing to Creative Finance & Management. We hope you find it helpful.

Thursday, 25 June 2009

The best way to cut overhead costs in big companies

This article describes the way that the principles of Activity Based Costing were used to cut overhead costs by approximately 20% in one large group that I worked for.

Activity Based Costing is the term given to a particular way of analyzing costs in order to manage them more effectively. It arises from the premise that costs are driven by activities. In other words you don’t just decide to employ a new person or buy materials or engage a consultant for the sake of it. You do those things in order to perform activities in the business. The more complex the manufacturing process, the more things have to be done to make the product (activities), and therefore the more people and materials have to be purchased to make it.

So thinking in this way is different to the normal way of looking at costs. Normally you have a profit and loss statement that says you spent so much on employing people, so much on occupying a building, so much on raw materials, etc. Looking at things that way is not completely useless, but it only goes so far. In a sense it answers that “what?” question. What have we spent money on?

Activity Based Costing (“ABC”) goes deeper to try to answer the “why?” question. Why do we spend money? What are the things we are doing that mean we have to employ this number of people, or buy this much raw material?

Now, in my experience, ABC is usually applied to manufacturing processes and direct costs. It allows insights to be gained into the costs of products. For instance, you may find that a costly activity in the process of making a particular product is the initial set up of the equipment. Therefore, you can make that activity more efficient be lengthening production runs. ABC therefore tends to go hand in hand with process analysis, because you can’t do ABC without analyzing the process. ABC is simply putting a cost on each activity in the process. Then disciplines such as Six Sigma, Total Quality Management, etc, come in to help to identify how the process can be improved. ABC leads to product profitability analysis and customer profitability analysis. In fact, it opens up many new ways of looking at the profitability of the business.

The one thing that is normally set on one side in Activity Based Costing is overhead cost. Overhead cost is primarily fixed or long term step costs, such as business management, Finance, HR, premises, legal, insurance, and so on. Old school management accounting would have said that if I want to work out the profits of each product, then I would have to allocate some of these overheads to each product on some basis. However, when I studied ABC I was told that allocating overheads to units of product (or anything, for that matter) was pointless, since products do not drive overhead costs. So it would be misleading to say that I make £2 profit per unit of a product, because it suggests that if I double my sales of that product I can make additional profit at £2 per unit. And that’s simply never going to be true. Doubling output may not lead to doubling overheads (one would hope not normally!). Or it may lead to more than doubling overheads if the additional volume takes the business past a major step (e.g. warehouse capacity). The point was that overheads should be left out of the analysis because it distorts things by including them.

That insight was music to my ears when I first heard it! At the time my monthly management reports were divided up with a page for each product. The direct costs were easy (in my case) to put against each product. But at the bottom of each page was an overhead allocation. Guess which bit of each product profit statement drew the most attention and argument each month? Yes, the overhead allocation! How much management time and energy was being wasted over something that was, to be honest, fairly arbitrary?! Overheads should be managed differently, and product managers should not have to justify the profitability (or otherwise) or their products with overheads arbitrarily allocated to them. I came straight back from my ABC course and took the overhead allocation out of the product profitability statements! Then we really started to focus on the real issues for the products – sales, margins, operational process efficiency.

But having set aside the overheads when looking at product or customer profitability, one cannot just ignore them. Having said they should be managed separately, how should they be managed? Certainly when I studied ABC, it did not seem to provide the answer. Perhaps I missed something!

Later on in my career I worked in a large utilities group, supporting their HR function in Finance and analysis matters. Across the group we spent hundreds of millions of pounds on overheads. And when the time came to tighten the proverbial belt, we had to find a way of getting to grips with the costs of overheads in different functions across different parts of the group. For example, the costs of HR did not just consist of a central HR department. There were about 12 different central HR directorates (ranging from Talent Management and Learning and Development through to Health and Safety and Occupational Health). Then there was the group HR Service Centre. And then each business unit had its own HR functions.

At my suggestion, to tackle the challenge we used the principles of Activity Based Costing to analyse the cost base and guide the decisions over where to make cuts.

First we asked each department manager to complete an Excel template. In this they listed each activity undertaken in their department, and against each activity they put a cost and headcount. The total cost and headcount for the department had to add up to the annual budget for the department. We also asked them to complete the latest forecast.

Since that information was still a little too granular we also asked the functional heads to categorise each activity in different ways. First, the activity driver – legal/compliance requirements; services required by other parts of the business; strategic initiatives; and “other”.

Speaking for the HR function, the analysis was pulled together practically by my Management Accountant, categorised by a 3-4 person working group, consisting of a couple of BU and central HR directors and myself, and then validated by the HR Leadership Team (the Group HR Director and her direct reports, including the Group Directors and the BU HR Directors). There were more than 400 rows of information, adding up to around £75m+ if I remember correctly. But, using the activity information in the data received, my Management Accountant and I came up with reports that could show the costs summarized in a few different ways to help the rather painful discussion.

The painful discussion was, having analysed the costs and categorized the activities, going through and further marking proposed savings against each activity. This started with senior HR Directors in each business unit discussing their own straw man proposals with the BU Managing Directors and their management teams. Then more pooling of thoughts and opinions within the HR Leadership Team. Then culminating with a presentation of a proposal by the Group HR Director to the Group Executive Committee.

The target cost saving had been given at the outset – there were to be 2 or 3 different proposals – small, medium and large! In other words they wanted to know what activities would be lost or cut back if they asked for cuts of 15%, 25% and 40%. So we knew what we were aiming at, at least in terms of analysis. The unknown was what the final savings figure would have to be. Each proposal to cut activities had to be accompanied by an assessment of the impact, strategically, operationally and tactically.

So you can see that ABC can be applied to overheads very easily, and gives a valuable and effective way of examining overhead spending especially when drastic cost savings are required.

The discussions that resulted from the analysis were very focused, well-informed and pitched at the right level of detail. The decisions were made confidently, in full knowledge of the impact.

… The sting in the tail of this story is that my own department was one of those where cuts were proposed in our activities, and the process resulted in my own redundancy (amongst many others)!!

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Tuesday, 16 June 2009

When Finance departments need to build bridges

The Marketing Director of a business I worked for once said in leading a seminar, words to the effect that, “functions like Finance, HR and IT are just overhead costs. They don’t add value. They don’t bring in new business or sell anything, and they don’t produce anything.” I didn’t respond at the time, but I remember being quite offended. I felt put down, as if he was saying that I was no value to the business. I was, at the time, I have to say, fairly naïve – this was my first job outside of public practice. What follows here are some of my reflections on the relationships between the Finance function and the other parts of a business, from working in more than ten different companies over thirteen years since then.

“Business Partner” – a misleading phrase

One thing that has mildly irritated me occasionally over the years is the use of the term “business partner” to describe aspects of functions that support and control the main activities of a business (which are providing goods or services to customers). In my experience, Finance and HR use the term a lot. I even use the phrase myself, because I know what people mean by it!

Normally, being a “business partner” simply means that the function or the individual is trusted to be involved in high level strategic decision making. This is as distinct from the mundane provision of information and operation of transaction or control processes.

I think the thing that irritates me about the term (albeit only mildly) is the misunderstanding it generates. This misunderstanding can be exposed by a few exaggerated statements:

- Some functions are not doing business, so they can only partner the business, or maybe just cost money. They don’t make or sell the product or deliver the service, so they are less important. So there are people you employ in your business that are not part of your business, but if you like them enough you may let them partner you in your business.

- Doing business is all about making the decisions, rather than the mundane processing and controlling. I, the CEO, and my board, are the business, because we make the decisions about the business. Business partners help me make decisions about my business. The other people in the functions are just recording, supporting, controlling and doing. The other people are not really part of the business. They just do jobs.

My view is: We are all the business, not a business partner. We all need each other. Not just the people making the big decisions. Not just the people making and selling and providing.

We all need to recognize the value of each other’s contribution to the success of the business. There is a passage in The Bible that speaks in this way about the church. It likens the church to a body. No one part of the body can call itself the body, but the body would not be a whole body without each part. Each part has its role and place, and importance, in the overall function of the body. The church is the body. So every member of the church has a gift and calling from God that contributes to the overall function and goal of the church. We cannot do without each other.

So it is with business I believe. We are all parts of the business, and without every part functioning properly and together the business will fail. This is my fundamental mindset when I deal with relationships in business. Each function and person must support each other in achieving the goal of the business – e.g. more customers, more sales, more profit, lower costs, a better brand, happy shareholders, stable cashflow, improved communities, etc.

So when managing a Finance team I encourage them to see themselves as helping the business to achieve its goals first, then in all their cross-functional relationships if they can help their colleagues it will ensure we are acting as one.

On the other hand when I speak with my colleagues in Ops, Customer Services, Marketing, HR, IT, and so on, I make sure they know what I am there for. Basically we are on the same side. I may have to challenge their spending or their performance against sales targets, question why they have not collected cash from customers quickly enough, set hard budgets, cut costs, and do many things they may not like. But if they know fundamentally that I do this, and Finance does this, because we are following our remit to help the business succeed – then it becomes more a question of asking for their help in achieving our objectives, whilst offering our help in achieving theirs.

Different personalities and skills suit different roles

Character differences produce a lot of friction. But it is possible to recognize that and get better at working together. Clearly Myers-Briggs, Insights, Belbin and the multitude of personality assessments demonstrate this clearly. But it is really self evident.

You get many different personalities in a team. And indeed everyone is different. But you also get certain personalities gravitating to certain roles and functions. I believe certain personality traits go with certain skills, although this is a generalisation that does not always work.

For example, an analytical person may gravitate to the Finance and IT areas, where there is a degree of set process, logic and numerical certainty. On the other hand, a sociable person may gravitate to areas that deal with people – HR, sales or marketing.

And each different business will require slightly different shades of characters within the different functions.

Recognising the strengths and weaknesses of certain character styles in different situations really helps to get people working well together. Instead of looking down on the marketing or sales person for the way they can’t understand the figures, or act unpredictably, we "analytics" can both help them with that weakness and seek their help when we need slightly more expansive and unstructured thinking. Working together creatively leads to competitive advantage.

Finance is sometimes seen as interfering

“What do Finance know about selling? So how can they give me these ridiculous targets?”

“What do Finance know about making our product? So how can they ask us to do it more efficiently?”

“Why do Finance ask us to fill in useless information on our transaction screens? They are just wasting our time.”

“Why do Finance always need an authorising signature on every bit of paper? They are the reason we are not as efficient as we could be.”

Finance people will be familiar with these and other similar accusations. How do we respond? How should we respond? Because one of the main things (though certainly not the only thing) a business is trying to do is to make money for its shareholders, Finance will always be in a central position and get its fingers into a lot of pies. And that can sometimes be seen as interfering in things we know nothing about.

The point I want to get across is that with every such complaint comes an opportunity for dialogue. That’s DIALOGUE! Not talking, not arguing our case, but constructive two-way dialogue.

But before I say something more about dialogue between Finance and other areas, I want to clear something up.

We Finance professionals are trained in Finance, normally first of all as accountants, and then analysts and financial managers. We are not (normally) trained in manufacturing, engineering, C++ programming or human resource management! So when we are accused that we don’t know these things, we should not try to make out that we do! We recognize there are things that we know and things that we don’t, things we are good at and things we are not.

But the next point is equally true – 99% of the time we don’t need to know either! For example, I may not know much about C++ or .net frameworks or web design, but when I challenge the IT department for employing contractors to develop an application, I don’t need to know all that. The thing I may need to know is what the application is for and how it will help the business (financially or non-financially). If they can’t tell me that, or their statement of benefits falls apart under scrutiny, then I have a right, as someone responsible for financial success, to ask them to stop. What we need to know is what is relevant to our remit as financial custodians.

But my main point is DIALOGUE. Every interaction with our colleagues, especially when we are challenged, is an opportunity to 1. Listen; 2. Understand; 3. Think; 4.Explain; 5. Change; and 6. Move on in working together (perhaps into a feedback loop so that the whole dialogue process continues).

1. Listen – Just ask them to tell you more, and then shut up and listen carefully. Finance does not have a monopoly on the truth. We don’t know everything. We need to learn. It also may be true that nobody understands perfectly the way the business works. Businesses are complex, they are made up of imperfect human beings, using machines made by human beings and computer programs written by imperfect human beings! Things never work 100% perfectly, and since we are not perfect we may in fact be the cause of the particular imperfection! This is your opportunity to learn about something in the business, and may turn into an opportunity to help.

2. Understand – Ask questions to get an understanding of the issue. Look for cause and effect. Ask who does what and when. Ask questions to help your colleague understand the issue they are raising. They may not fully appreciate what they are highlighting. You can help them simply by asking questions.

3. Think – Don’t just jump in with a suggested solution. Give it some thought. Go away and draw diagrams, process maps or play with spreadsheets if you have to. Ask other colleagues their opinion if you need to.

4. Explain – Ensure that your colleagues are aware of why you need information, or need things to be done in a certain way. What are the business consequences of them failing to follow procedures? Will we lose money? Will we pollute valuable information sources? Will we be less efficient? Get everyone on the same page. They may start to see how they can do things differently to achieve the desired result. There’s more likelihood of a win-win outcome if you understand each other’s perspective.

5. Change – If you need to. Being ready to modify things to ensure you can both achieve better results shows that you really believe you are both on the same side. It shows you appreciate their difficulties as well as your own requirements.

6. Move on in working together – if you have gone through this active dialogue then you will hopefully have solved a problem at the same time as making a friend and powerful ally. They will be both more ready to help you if you need something in the future, and willing to talk openly and less confrontationally about problems in the future. Keep the door open. Offer to review what you’ve agreed.

Final thoughts

Finance sometimes does not portray itself well. If you rely on Finance for anything it is to provide information on how the business is doing, and to make sure that transactions are managed and controlled efficiently and effectively. You rely on them to be able to analyse and tell you whether something will lose or make money. But sometimes we don’t do our job properly and lose respect and trust.

In those cases, in my experience, you have to be open, especially at a management team level. Explain what you are trying to achieve for the business, and how it will help. Share with your colleagues the problems you are having. Ask for help. There may be someone in another team that is good at process analysis, or good at Visual Basic macros, or good at training, or experienced in restructuring or integration. You would help them if they needed your help, wouldn’t you? And finally, keep sharing – share your successes and your problems. When you understand someone’s problems, share their successes and get involved in helping, you become more sympathetic. So get people on your side, because in reality they are already.

Finally, sometimes people in other functions don’t realize their actions have financial consequences. E.g. lack of detail in transactions leads to errors which leads to loss or time wasted. E.g. delays in dealing with Finance queries can lead to losses if it becomes too late to go back to customers to clear up errors.

Don’t just beat people up for doing the wrong thing and call them stupid behind their back. Go back to the dialogue outlined above, and educate them. I have found that if people realize the consequences of their actions, they are more likely to take care over doing things right. Point out where things are going wrong, and then start to listen to their side… then you’ve started a dialogue.

Conclusion

A business without Finance at the heart will be risking loss through errors, inefficiency or even fraud, and will risk making the wrong decisions through not understanding financial information. But Finance is not the business, and neither is it merely a business partner. We need to recognize the roles, remits, strengths, weaknesses and personalities at play across the whole business. We should value the diversity and work together to succeed in business through trust and open dialogue.

What should Finance do better to make relationships work? In short, better dialogue. You have two ears and one mouth – use them in that proportion! Be always more ready to listen than to speak. And communicate always with the assumption (whether or not there is evidence for it) that you are all on the same side, working for the success of the business.

Creative Finance & Management

Tuesday, 28 July 2009