Monthly Archives: August 2015

Should Finance Become an Analytics Powerhouse?

See why Finance finally has the right tools to excel in this function

Recently there was a discussion on the Proformative.com site whether finance should take over analytics and own the process, the advantages to the company and the steps required to do so. The following is the link to the discussion:  http://www.proformative.com/blogs/anders-liu-lindberg/2015/06/20/how-finance-can-become-analytics-powerhouse and I encourage all readers of this blog to become Proformative.com members as the site includes free membership and great resources and insight in all areas of accounting, finance, HR, corporate governance and more.

This is a great topic for discussion with many opinions and points of view, depending on which functional area of the company you visit. The general opinion in this particular Proformative discussion was that finance should own analytics and be tasked with providing management with the essential data that is necessary to run the company and steer it on its charted course.

Unfortunately, in many organizations today there is no central area where analytics is performed, along with reports, alerts and other research into variances anomalies. Many functional units (e.g., sales) do their own analysis of only the data produced by their business units or which are directly related to their area. With analytics being fragmented, and often incomplete and inaccurate, management cannot benefit from the real meaning of the data generated in their companies, validating the notion that there are many versions of the truth.  Centralized analytics is designed to change that.

What is analytics?

Analytics is the process of:

1)    Retrieving stored data from various company departments, divisions or business units, with historical as well as recent actual results of operations and financial data, plus the organization’s plan and budget data.

2)    Understanding the meaning of all relevant actual data collected and comparing to plan and budget data.

3)    Preparing reports using text and other visual aids to convey these data and their interpretations to individuals within management and other functional areas, supporting the decision making process.

When there is a plan and budget in place while monitoring the actual results and comparing with the anticipated results (as expressed by the budget and derived from the plan), meaningful information can be obtained when performing analytics.

The data used to perform analytics originates in several or many functional areas of the company. For example: Sales data, marketing data, accounting data of actual closed periods, etc.  It makes perfect sense to centralize the analytics process and have one owner over the process: The finance organization, reporting to the company CFO.

Information technology enables all data used in analytics to be retrieved by the analytics process owner and processed by the analytics software. The output, in turn, is a pre-defined set of reports and other visual aids (e.g., graphs, dashboards) designed to allow the user of these reports to quickly understand what these reports and visual displays are trying to communicate.

The CEO of a leading Planning, budgeting and Analytics software publisher defines this system as:

“A single source of accurate financial information- backward and forward looking- with the ability to integrate with Operations data- and that can be served up to end users for them to analyze themselves, and thus, allows them to contribute to the strategic and operational decisions and direction of the company in a timely (and informed) manner.”

The purpose of analytics is to give management the tools to be able to make timely and informed decisions with confidence. Having the right data reduces the risk of bad decisions, or decisions made long after the symptoms of trouble have actually appeared, when there is little that can be done to turn things around.

In a blog entry I recently made, titled “Why CFOs Should Adopt Financial Analytics”, I emphasize the need to have accurate, complete and timely information  that upper management can reasonably act on it, making decisions backed up by solid facts and not just intuition. It is the CFO’s responsibility (as the CEO’s second in command) to ensure that such data exists, is accurate and reliable, is available on a consistent basis and is presented in a manner that is simple to understand.

Since finance reports (or should report) to the CFO, it is finance that must develop the analytics process, acquire the right tools, implement them and use them on a regular basis, while communicating with the various business entities that generate the data.  Duplicating this effort in other departments, or having a fragmented system with incomplete or erroneous data is completely counterproductive, thus rightfully giving finance its status as an analytics powerhouse.

Does the Budget Process Need Changes?

Why the fundamental process is still valid but the outcome can be more useful and meaningful

I’ve covered a lot of material in the last 2 years here in this blog. Most of the entries made reference to the planning, budgeting and analysis processes, all of which are key elements in any corporate finance department. We saw why these activities must take place year round and why analytics is critical. We also saw why we have to use a purpose designed software solution to perform these tasks and why spreadsheets and certain software applications that employ spreadsheet-like techniques, including use of formulas and links, are not the right tools to use.

A major discovery we made was the ability to accurately and completely forecast a company’s future financial health, through automated forecasts of its Balance Sheet and Statement of Cash Flows, with their derived forecasted financial ratios all of which provide insight that can only be gained by reviewing these future period financial statements, along with the forecasted P&L.

I’ve expressed my opinion that this entire process should be performed in finance and owned by the CFO, who along with the CEO and other senior managers are the direct users of the presentation data generated in the analytics process.

What about the budget process itself? Does it require any changes? Is the traditional workflow, including the departmental submissions, the reviews and subsequent iterations of the budget still valid and necessary?

Fundamentally, certain aspects of the budget process are still valid and necessary.  Revenues must be forecasted in all divisions and business units and should include all product lines, with forecasting of new products and services, discontinuing existing products and services within the budget period where applicable, etc. Costs of inventory or services must be forecasted and clearly shown in the budget along the revenues they will generate. Operating Expenses and payroll must be budgeted and this is also true for capital expenditures and other miscellaneous income and expense. In order for a complete and accurate set of forecasted financial statements to be produced, all budget components must exist, be realistic and go though the review and approval process.

This implies that a review of all budget pieces submitted by regional managers, department heads and other responsible persons according to the organization structure must be conducted, revisions proposed and made, with final review and approval by management.

What is changing is how budget numbers are automatically calculated by the software and how future period financial statements and other management reports are generated and become available to users. Another major departure from traditional methods is the ability to seamlessly interface the planning and budgeting software to the company’s actual accounting general ledger, where actual period balances and even transaction level data can be automatically made available to the analytics software.

“Smart-Budget” software applications, such as Centage Corporation’s Budget Maestro with Analytics allows the budget to be developed from plan assumptions and user data, in combination with drivers and built-in business rules (e.g., cash for product A sales is collected in 30 days following the sale but in 60 days for Product B). Since there are no formulas, functions or links required anywhere in the program, budget administrators only need to rely on approved business units’ submissions of their budget data and the company’s selected business rules and applied drivers and other assumptions in addition to correct assignment of budget lines to G/L accounts, correlating to actual G/L accounts used in the company’s accounting system.

As each major area in the budget is entered in the system (e.g., Revenue and Cost, Personnel Expenses, Operating Expenses, Fixed Assets, etc.), the system automatically applies the selected business rules, drivers and G/L account assignments to produce, in real time, forecasted financial statements resembling the company’s actual financial statements. These reports, including an Income Statement, a Balance Sheet and a Statement of Cash Flows, plus any number of other desired reports, represent the state of the budget in any given point in its creation cycle and for each period in the budget. As changes to the budget are made, all reports are automatically updated. With different versions of the budget, and employing “What-If” scenarios, the output, including all presentation reports, graphs and other visual displays set up in the Analytics module, immediately respond to the requested data.

Summary

You can keep the annual budget process the same, but make sure you receive reliable and approved data from business units. Be sure to include all G/L accounts in the budget process (some will automatically be calculated), as it will ensure that you get complete and accurate forecasted financial statements. When applying business rules and assumptions, combined with use of drivers, you will essentially experience an extension of the company’s actual accounting into future periods.

Using analytics to display all key data and “seeing” future period balance sheets and statements of cash flows is the closest you can come to using a crystal ball to predict the future of the business. Remember that the output is only as accurate as the data supplied to the system and use of reasonable assumptions and drivers. However, there is a major and profound difference between this method and the traditional way where only revenue and expenses were part of the budget.

Although the basic functions of the budget preparation process and workflow remain unchanged, there are many valid and completing reasons why the traditional way of using the budget data output is no longer a viable option. More and more organizations are discovering that having the ability to forecast what the financial health of their companies is going to look like in future periods gives them the ultimate control of their companies’ destiny.

Those Hard to Forecast Numbers

Learn to use readily available data to forecast and display key financial information

Readers of this blog have seen several posts focused on the importance of regularly forecasting things such as a company’s Balance Sheet, a Statement of Cash Flows, key financial ratios, loan covenants compliance probability and more.

Why is this important?

As any finance manager or professional knows, much of the financial future of a company is dependent on correct interpretation of key data and decisions made based on that data.  Unfortunately, that data isn’t always readily available from actual accounting systems and from traditional budgeting and forecasting solutions. We’ve also seen in these blog articles that preparing a traditional budget and periodic re-forecasts usually involves only the income and expense accounts, producing a forecasted Income Statement for each period in the budget (e.g., month).

A forecasted income statement represents the results of a strategic plan used in the preparation of an operations plan.  Both are then used in building a corporate budget with forecasted revenues and the expenses projected to generate these revenues. Usually, the more ambitious forecasts will show more aggressive growth with usually greater forecasted earnings, which may look promising but can actually signal trouble ahead.

This type of budget, while necessary in any business, fails to deliver the most important set of data,  the forecasted financial position of the organization (as represented by a forecasted balance sheet) for any version of the budgeted P&L. As we’ve seen in this series of blog entries, the financial position of any organization is an indication of its financial health.  Predict the future financial health of your company and you’re much more likely to make better, more accurate and more timely decisions. Fail to do that and you are likely to deal with severe consequences of poor planning and deficiencies in executing a plan based only on revenue and expense goals.

The conclusion of all this is that a forecast consisting only of revenue and expenses is not only incomplete but may in many circumstances be unrealistic, and in all cases cannot predict the likelihood of a company’s future financial health either improving or deteriorating. The reason for this is that a budget consisting only of revenue lines and expenses, prepared on an accrual basis, will not tell you whether or not you can actually achieve the goals listed in your plan and entered into your budget. This presents several important questions:

1)    Will you have sufficient cash to accomplish what your budgeted P&L suggests?

2)    Will the timing of your cash flows (e.g., A/R collections, A/P payments, payroll disbursements) allow you to maintain the desired cash balance in each period?

3)    Will you be able to acquire the assets needed in order to produce the inventory or service lines projected to achieve the desired revenue?

4)    Will your financial ratios be satisfactory throughout the budget period?

5)    Will you be able to comply with your loan covenants requirements?

6)    In summary:  Will your financial health improve or worsen during the budget period and by how much?

The clear answer to these questions is: Without a forecasted Balance Sheet there is no way of reasonably answering any of these questions. You may be holding in your hands an approved corporate budget book that cannot be executed on, even if you had the ability to book the projected sales and find ways to adhere to your budgeted expenses.

What’s worse, you can’t run multiple versions of your budget and see how your financial position changes in future periods in response to these different budget versions, so you can adjust your plan and budget and make other changes that will allow you to meet the plan and budget objectives.

As you may have already found out, it is very hard and risky to base your operations on an incomplete budget, one that makes it a easy to miss the budget numbers altogether.

In past blog posts we saw why most organizations do not forecast their balance sheets:  Why you Must Forecast your Balance Sheet (Part 1 and Part 2) and Forecasting a Balance Sheet in a Spreadsheet World. This is just too hard to do using traditional tools such as spreadsheets . It is also becoming apparent that most dedicated planning and budgeting solutions were never designed to deliver a true budgeted balance sheet due to their architecture and relying on spreadsheet-like use, with formulas, functions, links and other user supplied programming, and no “accounting-like” transactions that maintain ending balances in all forecasted GL accounts. You simply can’t add up columns of numbers and arrive at the balance sheet account balances like you do with an income statement. See Those Debits and Credits blog entry.

Those who regularly visit this blog know that I like working with Budget Maestro with Analytics – published by Centage Corporation – mainly because of its unique architecture that enables users to obtain a forecast of their company’s future financial position (i.e., the Balance Sheet), closely representing the organization’s future financial health, and often well in advance of potential adverse changes to the financial position. I think this is a new and positive trend in the development of CPM and Budgeting / Analytics software which to me it seems like a wave of the future.

I don’t know of any other software publisher that implemented Centage Corporation’s philosophy and vision, but I sure hope other developers adopt these principals and offer competing solutions that will allow their users to use the vast amounts of data available from their ERP software, combined with smart budget data, in order to deliver a clear picture of what lies ahead in terms of financial health and stability.

I just want to see more companies embrace this technology and use it to their advantage and by doing so eliminate an old, incomplete and deficient process, often regarded a chore or a ritual more than a productive process with useful and meaningful results.