For more than a decade, studies such as Ernst & Young’s DNA of the CFO, have clearly recommended that CFOs should act more strategically and more commercially, helping to improve performance through the timely sharing of informed insight with business decision-makers; but in practice, this is still rare.
The credit crunch and subsequent recession has left a significant number of organisations struggling to adapt, with the finance functions of businesses in affected sectors focusing on reducing costs in an attempt to protect profits in the face of stagnating or falling revenues. Poor understanding of cost drivers, cost profiles and, ultimately, what leads to margin contribution, left many organisations arbitrarily cutting costs to achieve quick wins: this approach may have alleviated short-term pressures, but will likely have a damaging impact on the company’s underlying capabilities.
The problem is that many organisations still do not have the information nor the processes that allow clear disclosure of the true cost base, or a true understanding of how costs correlate to value-creating activities within the business. Additionally, despite the global trends in outsourcing and in de-risking supply chains, it has become obvious that many businesses continue to rely on fixed cost models of maintaining full control over their supply chains. Leading organisations have proven that moving from fixed costs to a variable cost base helps them accurately predict demand and vulnerability in supply; and this transformation is driving a fundamental change in attitude to business and operating models.
With business confidence remaining fragile, organisations will still need to be cautious in exploiting growth opportunities. It is more difficult to determine how to grow marginal revenue and profit contribution than it is to cut costs while hoping to protect the top line. Rather than “Where should the next unit of money be saved?” the question is now “Where should the next investment be made?”
The CFO’s strategic role
The lack of predictive ability and agile response to economic turbulence has demonstrated that many organisations lack the skills and resources within their finance functions to manage sustainable performance. The CFO too often acts as a mere observer of performance, rather than an active value-adding “business partner.”
As part of being a true business partner, a CFO should facilitate and encourage transparent financial performance and cost allocation across their organisation, and ensure that business decisions are grounded in sound financial analysis.
Understanding how to make the best use of natural resources, assets and labor will help the organisation make changes in strategy affecting new product development, deployment of human resources, pricing decisions or production schedules. Decision-makers want to be confident that the actions they are taking will deliver their economic objectives, or that investment strategies can be pursued without the fear that a greater opportunity is being missed elsewhere.
Vital decisions that maximise marginal contribution, linked to maximising shareholder returns, are made through the planning and performance management process; therefore, by making a deliberate effort to own this process, the CFO will be at the heart of economic decision-making in their organisation.
Enabling better economic decision-making
With companies making thousands of resource allocation decisions a day, there is a clear dependency on timely access to targeted, relevant information. To optimise revenue growth and maximise profit, CFOs need to focus on understanding how to allocate the organisation’s limited resources to the areas of the business that can drive marginal contribution.
To be effective, organisations require internal processes that drive robust financial challenge and accountability, giving the right information to the right people at the right time. A fit-for-purpose performance management framework should be able to identify the most important decisions for the business, and be widely and consistently used as the mechanism for communicating them and measuring progress against targets.
Ernst & Young has developed an “enterprise value chain framework” which, when applied to performance management, will identify an organisation’s pressure points. By focusing on the four framework components, CFOs can quickly understand where they need to deliver insight to the business to drive shareholder returns and manage organisational performance:
Providing strategic direction – CFOs have responsibility for ensuring that resources are in place to deliver the financial targets determined by the corporate strategy, and for providing insight and analysis of fundamental information to enable the entire company to execute against his strategy. The CFO must understand the company’s core competencies and markets; how they compare with the competition, how they fund their corporate strategy and what financial return they are seeking.
Generating customer demand – The CFO should be able to offer insight and analysis on profit and revenue drivers; this involves recognising the considerable impact that sales, marketing and customer service has on volume and pricing decisions. The company should adopt a realistic demand forecast; ensure that pricing models properly reflect costs; effectively manage customer working capital; understand the optimal product and services mix: and know how to optimise cost to acquire and serve customers.
Fulfilling customer demand – To facilitate the flexibility and agility of the company’s cost base and its ability to react swiftly to changes in customer demand, the CFO will need to provide insight and analysis on the direct cost of supply chain, manufacturing and production. This includes having a realistic production forecast; understanding how the cost of supply varies with changes in volume; ensuring that supply chain working capital is being managed effectively; and identifying the best time to make investments in new assets.
Providing support services – The CFO should lead the organisation’s efforts to understand and make efficient use of scarce resources from an economic viewpoint that will maximise the return for the company, and support HR, legal and compliance requirements. The company should understand and measure performance against targets, incentivise people to deliver organisational targets and communicate performance to stakeholders effectively.
In summary, the CFO must act as the guardian of performance management, checking that agreed processes are followed so that the desired outcomes can be achieved. The finance function must develop aligned performance management processes, and translate insight and understanding into rational decisions that maximise the desired economic return.
By basing activities around the enterprise value chain framework, CFOs will be able to channel their function’s performance management efforts toward providing insight in the areas that will be of most value and, in doing so, they will be seen as the company’s valued economic advisor.