Financial fitness – upping the performance of your finance function

Series to look at metrics after survey shows most companies are unhappy with performance management. By Lisa Higgins, chief operating officer, APQC.

In August, Insight will begin a series of articles, called Financial Fitness. It will focus on how to improve the performance of your finance function. The series will take one metric each month, such as accounts payable, and look at ideas and advice from leading experts on how you can raise your game in that area. We also invite readers to contribute their own ideas for improving performance – for more information see below.

Consultants talk perpetually about best practices. For managers the obvious response is to ask, ‘But what is the business value of these practices?’ It’s not logical to undertake a major software upgrade or process reengineering project if you’re not confident that you’ll achieve tangible returns from your investment.

The American Productivity and Quality Center (APQC), an independent, not-for-profit organisation, conducted a survey to find out whether today’s most popular business performance management (BPM) best practices are yielding results.

What’s wrong with BPM?

Many companies are highly dissatisfied with both the processes involved in and the results derived from their planning, budgeting and forecasting. The survey asked respondents to evaluate their processes through a series of quantitative and qualitative questions. A large proportion of respondents levelled harsh criticisms at their BPM processes, including:

• budgeting is mainly a number crunching exercise (47 per cent)
• the plan is not clearly linked to strategy (56 per cent)
• technology makes the process neither faster nor more effective (63 per cent)
• targets are not strongly linked to external economic data (67 per cent)
• different functions do not talk to each other during the process (46 per cent)
• the company often misses earnings targets (30 per cent).

Many respondents are also dissatisfied with the timeliness of their budgets and plans. 46 per cent said that their budget quickly becomes outdated, yet only 40 per cent said that the plan is regularly updated during the year. This isn’t surprising in light of the amount of time companies are spending on the budgeting process. When respondents were asked how long it takes his or her company to prepare its annual budget, the average response was 78 days. That means that only half of respondents finish the process within two and a half months. The fastest companies prepare their annual budget in less than 45 days but the slowest dedicate more than 90 days to each annual budget cycle.

In our experience of collecting benchmark data, there is evidence that decreased cycle times in planning, budgeting and forecasting processes lead to better business outcomes. Shorter cycle time is naturally associated with lower process costs. Time is often of the essence in a budgeting process. Assumptions about the business environment or market behaviour made 90 days before a budget is completed are much more likely to be incorrect than those made only 30 days in advance.

APQC believes that reducing BPM-process cycle times is crucial to improving corporate performance. It therefore used the survey to examine the relationships between a company’s budgeting cycle and its advancement in several methods of performance management:

• reduction of reliance on spreadsheets
• use of a single instance of enterprise resource planning (ERP) software rather than multiple instances
• rolling forecasts
• activity-based budgeting
• the alignment of the organisation around corporate strategy.

We identified which respondents use what they consider to be leading practices in each area and which still use more outdated practices. We then compared the budgeting cycle times of both groups.

Graph 3: leading practices’ impact on the budgeting process

Leading practice	Lagging practice
Spreadsheet use
35.6% of respondents Moderate, light or no reliance on spreadsheets in the budgeting process.	64.4% of respondents Heavy reliance on spreadsheets in the budgeting process.
Single-instance ERP
54.2% of respondents Implementation of a single instance of corporate enterprise resource planning (ERP) software.	45.8% of respondents Implementation of multiple instances of ERP software within the company.
Rolling forecasts
44.6% of respondents Preparing forecasts (typically quarterly) that have a standard time horizon looking 12, 18, or some other number of months into the future.	55.4% of respondents Absence of rolling forecasts. Typically means that the only time horizon for financial forecasts is the end of the current quarter or fiscal year.
Activity-based budgeting (ABB)
26.4% of respondents Using operational, non-financial measures to help drive creation of the financial budget.	73.6% of respondents Absence of ABB. Typically means preparing a budget focused on standard financial line items.
Alignment with corporate strategy
42.5% of respondents Budget is fully aligned with strategy and aligned with rewards.	57.5% of respondents There is no relationship between budget and strategy, or they are loosely aligned.

 

Spreadsheet use

Only 37 per cent of respondents said that the technology they use to support planning, budgeting, and forecasting makes those processes either faster or more effective. This means that 63 per cent are giving a thumbs-down to their BPM systems.

One likely reason for this is the prevalence of spreadsheet use in corporate budgeting processes. While a package such as Excel is fine for individuals, it is much less effective than specialised budgeting and planning software at managing the quantities of data required by BPM processes in a sizeable company.

Whenever a company uses a plethora of spreadsheets for BPM, it faces the challenge of keeping track of data. Also, these tools cannot provide version control functionality and they frequently experience broken data links. Nevertheless, 64.4 per cent of respondents said that they rely heavily on spreadsheets in their budgeting, planning and forecasting processes. Only 5.3 per cent said that they rely on spreadsheets lightly or not at all; 30.3 per cent stood the middle ground, claiming ‘moderate’ use.

The impact on cycle time is telling. Those who use spreadsheets extensively take an average of 30 more days to complete their annual budget than those who rely less on Excel.

When planning software vendors come knocking, finance and IT managers may do well to answer the door. The research doesn’t mean that replacing spreadsheet-based processes with more sophisticated BPM software is a magic bullet for cutting cycle times. It does, however, indicate that the change can make a dramatic difference in a finance department’s efficiency. In fact, if a BPM software vendor won’t promise to cut at least 30 days off your budgeting cycle time, perhaps you should ask why.

Single instance ERP

Running only a single instance of your company’s ERP software can make a significant difference in the amount of time required to prepare the annual budget. Companies with a single instance of ERP have an average budgeting preparation time of 62 days. Those with multiple instances (including both companies with multiple instances of the same software and those using several different packages) have an average annual budget cycle of 90 days.

APQC’s experience is that using a single ERP system greatly reduces the need for finance to spend time crunching numbers when creating the company-wide budget. A company with a single ERP installation is much more likely to have a single chart of accounts. It will also be more likely to have standardised definitions for calculations of values such as gross margin, and common reporting capabilities. All of these make life easier for the department in charge of compiling corporate budgets.

Unfortunately, finance rarely has the authority to insist that a company run a single-instance ERP environment because it is only one of many stakeholders involved in ERP decisions. But when a company’s ERP environment comes up for re-evaluation, there is empirical evidence that reducing its complexity leads to a faster budgeting cycle.

Rolling forecasts

Rolling forecasting – preparing regular forecasts (typically quarterly) that always have the same time horizon – forces a company to look beyond the end of the current fiscal year in its recurrent planning. Rolling forecasting is a hot topic often discussed at BPM-related conferences. In fact, it’s popular enough that 44.6 per cent of those surveyed said they are using it in one form or another. This makes sense. Rolling forecasts should eliminate some of the problems created by budgets quickly becoming outdated in 46 per cent of organisations, but only updated regularly in 40 per cent.
 
Businesses contemplating this method often mistakenly believe that, every quarter, they will have to go through the whole annual budgeting cycle again. Companies using rolling forecasting spend an average of seven days working on their quarterly forecast. This is precisely the same length of time required by the average company that does not forecast beyond the current year-end. This shows that rolling forecasts do not require an organisation to rehash the entire budgeting cycle each quarter. As well as the qualitative benefits achieved by companies through better planning outcomes, those that use rolling forecasting save an average of 25 days on their annual budgeting cycle.

Activity-based budgeting

We define activity-based budgeting (ABB) as the use of operational, non-financial measures in the creation of the financial budget. Organisations using this practice may or may not have a full activity-based costing system.

For example, a call centre might base its budget on the number of calls it expects to receive during the year, rather than on expected staffing needs or standard salary increases. The effect is to incorporate elements of a business operations plan into the financial budget. This practice can move budgeting away from an exclusively financial exercise and towards the incorporation of key business drivers. A 2003 study by CFO Research Services indicated that only 27 per cent of respondents felt their budgeting process focused mainly on key business drivers. The other 73 per cent said they focused mainly on standard line items. A similar question on our survey revealed a similar distribution: only 26.4 per cent said they are using activity-based budgeting.

Most respondents to the CFO study expected to change their processes within three years to focus mainly on key business drivers – an expectation not yet realised according to our survey results. For those considering implementing activity-based budgeting, our survey reveals a strong business reason to do so: the budgeting cycle is around 20 days faster for companies that use ABB than for those that don’t.

Alignment with strategy

Aligning a budget with corporate strategy is not so much a business practice as an outcome of implementing the other best practices successfully. We investigated whether companies take longer to prepare a budget that is aligned with corporate strategy than to prepare one that is not linked. The answer in our survey was a resounding ‘no’. In fact, preparing a budget linked to strategy appears to take less time. If you begin a budgeting process with clear business goals and outcomes in mind, it should reduce the amount of time spent arguing about and adjusting minor details.

We did not, however, find a significant relationship between respondents’ practices in other areas of budgeting and their budgets’ alignment with corporate strategy. Whatever method they use it seems to have no impact on whether they consider budgeting and strategy to be aligned.

Companies looking to shorten their BPM cycles should consider the potential benefits of each of these practices, but none is a panacea for a strictly tactical budgeting process.

To benchmark your organisation’s finance and accounting processes with those of the survey respondents, go to the APQC survey.

This article first appeared in Business Performance Management magazine.

Financial fitness – the series

Starting in August we will look at one metric for measuring the performance of the finance function per month. We plan to look at the following:

• payroll (number of payroll disbursements per ‘manage pay’ full time equivalent)
• accounts payable (total cost of the process per invoice processed)
• general accounting (cycle time in days to perform annual close at site level), and
• total cost of the finance function (as a percentage of revenue).

Would you like to contribute to the series with your own ideas for or experiences of improving these metrics? Perhaps you would like to suggest some other metrics to analyse? Please email tim.cooper@cimaglobal.com. Do not write more than 200 words per metric, please.

June 2006