By Andy Burrows
[First published 6th March 2017]
[This article is also on LinkedIn - why not "Follow+" Andy and give the article a "like"?]
This is part of a series of articles looking at Finance activities, and basically asking 'why?' The premise is that understanding why we do things helps us to do them better. It may even fundamentally change the way that we do them. If you haven't seen it already, take a look at the introductory article that explains the approach I'm taking: The Purpose-Driven CFO Part 1: Why be Purpose-Driven?
I’ll give you the links to the other articles in the series at the end.
Of all the areas of activity in Finance, the one that is probably most taken for granted (aside from transactional activities such as invoicing and Accounts Payable) is Financial Reporting. I’m guessing that even asking the question, “why do we do financial reporting?”, would get quizzical looks. What do I mean, why? It’s just something we do. If we didn’t do financial reporting, what would Finance be there for?
Monthly reporting of a full, detailed, P&L is something that is done in, I would bet, 100% of Finance departments in the world. Reporting of the Balance Sheet and cash flow would probably be less than 100%. Would that change with a purpose-driven approach? What would change by asking ourselves why?
What we find is that this purpose-driven approach forces us to think about who is asking for financial information, and what they need it for. And thinking through the implications of the use of financial reports could help us to be more efficient, as well as helping us to deliver better value to the business.
I tend to think of the use of financial reports in three categories. I guess you could call it a pyramid, or a hierarchy, because the categories seem to map to levels of management. But I have a feeling that there may be areas of overlap. The categories specifically relate to the purpose for which financial information is needed, rather than particular stakeholder groups. However, particular stakeholder groups will naturally focus on particular needs. Here’s a table to start us thinking:
General report characteristics
Investors, Group, Lenders, Regulatory bodies (e.g. Companies House, PRA)
Determined format/content; Less frequent; Summarised; Longer view (but normally looking back)
Business Performance Management
Executive/senior management, Board, Audit Committee, etc
Longer view (looking forward); focused; flexible format/content; more frequent; variable level of detail
Operational Management and Control
Finance, cost centre managers, team managers
Detail-rich; more frequent; short term view (~3 mnth);
At the level of Corporate Governance, what those stakeholders want to be assured of is that the directors are running the business responsibly, and that the business will deliver the financial returns they want. The decisions they want to make based on this information are ownership or regulatory decisions – do they want to continue to invest in the business? Would they put more money in if required? Are they operating within the rules? Financial reports are geared to help them with that.
At the Business Performance Management level, the use of financial reporting information is normally part of an assessment of whether the strategies of the business are being successful. Is this business performing as well as it should? What areas are doing well? What areas need some help? The stakeholders that are normally interested in this are the senior management, the strategic decision makers. The decisions that may be based on this information would be strategic decisions – products, locations, customers, deals, partnerships, marketing, PR, etc.
Operational Management and Control is all about the day-to-day, making sure things are on track and under control. Stakeholders are managers “at the coal face”. The decisions they need information for are operational decisions – can we recruit a new person? Should we order this kit? They aim to spot transactional problems (e.g. approvals not being given correctly, transactions miscoded, policies not followed) as early as possible and rectify them.
Going back to the ‘top’ level – Corporate Governance reporting - we’re fortunate that the format and content of these financial reports is usually fairly well-specified and doesn’t change much. They’re also quite high level, so they don’t normally involve much thought in designing your ‘chart of accounts’ to fulfil these obligations.
We do need to be careful, though. With private companies, and businesses where the owners and investors have a very close involvement in management, there can be a lot of overlap. This can be confusing. The value in differentiating ‘ownership’ drivers of reporting from ‘performance’ drivers goes back to the way we were looking at strategy in my previous article.
What the owners/investors/lenders want, in terms of the return they want, the type of business they want, the risk profile they want, and so on, determines the targets, limits and parameters against which business management can operate and the strategies that can be employed. Reporting to them on these things, as regularly as they need to know, will be the ultimate proof of whether the business is succeeding or not.
The measures are normally quite simple – earnings per share; return on equity; gearing ratios; interest cover; cash conversion ratios; etc. And since the requirements are from the owners and from regulatory authorities, these are requirements we simply can’t get away from. These effectively set the minimum level for financial reporting.
Measuring the performance of the business against its strategies, on the other hand, is normally much more detailed and complex. So it’s worth making the distinction. But there is a relationship between the levels. The way it should work is that business performance measures cumulatively indicate how well the business will perform against the governance and ownership measures.
I’ve deliberately skipped from top level to bottom level – Operational Management and Control reporting - partly to highlight how different things are at the other end of the spectrum. But also, I wanted to leave the Business Performance Management level until last, because I think that is where the most valuable questions can be found.
When we get into the realms of management reporting, this is where it’s best to try to understand what your managers need. That doesn’t mean just asking them. It’s actually better to get really close to them, and understand what their departments do. Then you can suggest where you have information that might help them, as well as helping to devise new ways of looking at things. This is where Finance moves from being a servant of the business (fulfilling requests) to being a partner in the business (involved in dialogue).
For instance, you may find that the warehouse or production department needs daily or weekly information on future orders, product sales and stock levels. This helps them to make sure they’ve got their resources allocated and their production planned correctly. Where is the information going to come from? It’s often, although not always, the case that it’s held within Finance. And Finance reporting obligations then become critical to the daily smooth operation of the business.
The requirements at this level also include financial control. It’s worth saying somewhere along the way that part of the reason we do monthly accounts is to make sure that transactions are being accounted for correctly, and are controlled per agreed business policies. So, we run through a monthly exercise to check that sales invoices are correct, cash is allocated correctly, suppliers have been paid, and transactions are coded correctly. If we only did this once a year we would not pick up problems soon enough, and the year-end would be a nightmare.
The Business Performance Management level could also be referred to as the strategic management level. The purpose of reporting at this level is to monitor the success, or otherwise, of the strategies being employed by the business.
I made the point earlier that this is normally quite detailed and complex. The reasons for this are obvious when we step through the process for designing performance reports.
First, we have to be clear what the strategies are. At the same time, we must specify what these strategies are trying to achieve. What are the desired outcomes?
Then, the desired outcomes have to be expressed as SMART objectives, with the emphasis on the S and the M – Specific and Measurable. In other words, for each desired outcome we have to define how we are going to measure it. This is where KPIs (Key Performance Indicators) come in.
And once you’ve agreed the appropriate KPIs, you have to work out where you can get the required information on those KPIs. Is the information readily available? Do you have to change systems to capture new information?
And since, as we saw in the last article, business strategy should be flexible and dynamic, the information requirements may change. So, we also need information and reporting systems that are flexible enough to cope with that.
This has four implications that are worth thinking about.
Strategic direction will influence the way that the business wants to see financial information. And this, in turn, will lead to questions over how to get the information out of the accounting system in the categories required. And therefore, those category codes will somehow need to be applied to transactions during the transaction recording processes.
There’s not space enough here to go into the variety of ways this can be achieved. Each accounting system (ERP system) is different and has its own way of catering for the various codes you might want. And indeed, there may be choices to make over the fields where the category data is held.
The kinds of things you may be thinking about are products, customers, regions, sales channels, sales personnel, etc, on the income side. On the expenditure side, cost centres, departments, functions, projects, direct/indirect, etc, are some things to build in.
But we need to think not only about what information we need out, but how we intend to get it out, and what reporting system we will use.
It can be quite a complex area, and is something that should be thought through carefully. Coding structures can get horribly out of shape and broken over the course of years, and often the only way to sort it out is to completely re-implement the ERP system. I’ve seen that happen in two very large businesses I’ve worked with. Getting something in place that is robust and future-proof will save a lot of money and wasted time over the years.
If your strategic KPIs involve non-financial measures, or even financial information that isn’t held in the ERP system, the way that data is collected and held will be worth thinking through. It needs to be collected consistently, and held in a robust database. And the reporting mechanisms need to give ease of access and flexibility.
This strays into the area of “Big Data Analytics”, which is something I am not an expert in. The point is that if a KPI is really key, then the data to support it is critically important. And therefore, having an appropriate way of collecting, maintaining and reporting the data, so that you can rely on it, will also be critically important. Whether this means you need a “Big Data” solution is a separate question.
Please correct me if I’m wrong – as I said, I’m no expert in this – but my understanding of the rationale behind “Big Data” is that it works on the premise that collecting and maintaining as much data as possible will give your business the widest range of diagnostics to draw on. All I’m saying here is that if performance reporting is reporting against business strategy, and if KPIs for measuring strategic performance involve non-financial and granular data, then “Big Data” is worth considering.
There’s another implication of recognising that reporting at that Business Performance Management level can be both financial and non-financial. And that is that it pushes Finance outside the realms of merely financial reporting. And non-financial data is normally held outside the core Finance systems, and is normally the responsibility of other parts of the business to collect and maintain.
What I’ve seen in the past is that those other parts of the business then take it upon themselves to build their own reporting solutions on their data. And that can lead to problems.
Firstly, other parts of the business may be resistant to Finance taking responsibility for reporting on their data. Why should we? Surely we won’t understand it?!
Second, even if Finance can get their hands on the data and report on it, the other parts of the business may still do their own reporting. And if they use slightly different definitions, time parameters, etc, this can give inconsistent results. This, in turn, leads to time-wasting discussions over which figures are correct.
Third, other parts of the business may not have the analysis skills needed to report accurately. So, the quality of their reports may lead to inconsistencies.
This means that Finance needs to tread carefully. We need to be persuasive, proving our capability and our understanding of the business and its strategy.
I truly believe that the Finance function is all about business performance management at its core. And therefore, its reporting of business performance should not be limited to financial KPIs. There should be one suite of business performance information, with reporting under one responsibility, so that it can be looked at holistically and consistently. I also believe that doing it this way makes it clear that the purpose is to manage business performance.
So rather than having a financial report from Finance, an IT report from IT, a HR report from HR, a customer service report from Customer Services, etc, I believe that the senior management team should have one holistic business performance report. This could be called a Balanced Business Scorecard. I’ve seen these used to good effect.
Finally, if reporting at the Business Performance Management level is aimed at measuring performance against defined strategies, do we really need a load of accounting information to be produced each month? And even if that information is needed for financial control purposes (see above under Operational Management and Control Reporting), does it need to be included in the reports that are given to senior business management?
A couple of examples:
It’s worth critically assessing every element of your monthly financial reports – every row, column, dimension, label, page, commentary – asking whether the amount of information in those elements is saying anything meaningful about performance. Why is it there? Why do you report it? If you saved time by not including it, not calculating it, not putting it into the ledger, etc, would it make any difference to the view of performance? Would it make any difference to financial control?
This is another angle that can help to make Finance more efficient in order to focus on adding value to the business.
We’ve looked at the big question of why we do regular management and financial reporting. And we’ve discovered that knowing who needs information, and what for, can enable Finance to keep perspective, be more efficient, and to add value through business performance management reporting.
Reporting turns out to be another area where purpose-driven thinking – asking why we are doing something – makes a difference to the way we think about things. And therefore, it makes a difference to what we do and the priorities we have in Finance.
So – so far, I’ve applied purpose-driven thinking to budgeting (part two), to strategic planning (part three), and to reporting. I think it’s been a worthwhile exercise. What do you think I should consider next?
To save you looking, here are the links to all the articles in this series:
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