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Douglas Hicks

21st century financial planning and analysis

How to formulate an effective business strategy and execute it successfully.

May 29, 2012
by Douglas Hicks, CPA

In the world of management accounting, knowledgeable and capable accounting professionals share a common language and yet the words can have different meanings to different people.

For example, financial planning and analysis (FP&A) represents the budgeting and forecasting processes for one, while it means variances, efficiency measures, and trend analyses for others. For still others, it means scorecards, dashboards, and other performance measurement tools. Although none of these views of FP&A is wrong, none of them is correct.

A simple definition of FP&A is this: The provision of economically sound concepts and tools that will enable an organization to formulate an effective business strategy and then translate that strategy into results. Under that umbrella definition fall many of the individual concepts and tools advocated in the management accounting marketplace—most of which are value-enhancing ideas and methodologies, but none of which constitutes FP&A on its own.

Critical to effective FP&A are the abilities to:

  • Provide comprehensive and economically sound information.
  • Use that information to support the formulation of an effective business strategy.
  • Facilitate the execution of that strategy and generate the desired results.

Much of the information necessary for FP&A to work effectively comes from outside the domain of the financial executive.

Marketing needs to provide intelligence about customers’ likely responses to new products, services, or pricing policies—and the resources necessary to promote the company’s goods and services.

Reader Note: Don’t miss meeting Douglas Hicks at the upcoming AICPA Financial Planning & Analysis Workshop, July 12-13 in the AICPA Boardroom, New York, NY.

Operations and engineering need to provide intelligence about the internal steps and capital investments that will be necessary to perform the services or produce and deliver products.

Human resources needs to provide intelligence about the availability and capability of workers needed to fulfill demand and the compensation required to attract those workers.

Every function within an organization needs to be involved in FP&A. It falls to the financial executive, however, to coordinate the efforts of these individuals and then convert their inputs into accurate, relevant, and actionable economic measurements, targets, tools, and plans.

Comprehensive and economically sound information

The first requirement—providing comprehensive and economically sound information—requires that a valid economic cost model of the organization exist. This means not only that a valid structural model incorporating all of the organization’s key processes must exist, but that the model must be populated with economically sound cost information.

To be structurally valid, the cost model must follow the cause-and-effect relationships that are the basis for activity-based costing—not just as a means of assigning costs to the processes, products, services, and customers who cause them, but also to facilitate the projection of costs when alternative strategies are being considered, possible improvements are being planned, or potential major expenditures—both capital and noncapital—are being evaluated. In short, the model must be bi-directional. It must assign and project costs effectively.

Without sound economic cost information, however, even a structurally valid cost model is ineffective. To ensure its long-term value-creating ability, a company cannot rely solely on cost information as defined by current financial accounting practices. This means that the aberrations in measured costs that occur during specific accounting periods must be normalized, for example:

  • Higher or lower spending on repairs and maintenance, research and development, or marketing during a specific period cannot be accepted as representative of the long-term sustainable economics of the business.
  • Depreciation expense cannot be relied on as a true measure of the ongoing capital investment required to maintain an organization’s existing capabilities.
  • The cost of capital cannot be omitted from an organization’s cost structure.

Formulating an effective business strategy

An organization that can provide management with comprehensive and economically sound cost information has a much better chance of formulating an effective business strategy than one whose management relies on a conglomeration of unrelated data rolled up into averages.

Without sound cost information, a company cannot accurately measure the value to the organization of its products, product lines, customers, or markets. It cannot assess the impact of dropping or adding products or customers correctly or emphasize one product line over another. It cannot accurately determine the bottom-line impact of insourcing, outsourcing, or offshoring. In such an environment, management must either rely on flawed information or intuition, both of which tend to result in ineffective, and sometimes fatal, business strategies.

With comprehensive and economically sound cost information, management understands the organization’s “profit zones”—the areas in which it has advantages over its competitors—and can both formulate and test strategies that exploit those advantages. With an effective strategy formulated, an organization can then facilitate its execution with a well-designed enterprise performance management (EPM) system.

Facilitate the execution of strategy

Strategies do not implement themselves. The key to executing strategy is the EPM system.

EPM can be defined as the process of managing the execution of an organization’s strategy. It gives an organization the capability to quickly anticipate, react, respond, and anticipate problems earlier in the time cycle. In the end, organizations need top-down guidance with bottom-up execution.

EPM integrates operational and financial information into a single decision-support and planning framework. These include strategy mapping, balanced scorecards, costing, budgeting, forecasting, and resource capacity requirements planning. These methodologies fuel other core solutions such as customer relationship management (CRM), supply chain management, risk management, and human capital management (HCM) systems, as well as lean management and Six Sigma initiatives. It is quite a stew—one that will have a different recipe for each organization, but they all blend together.

Conclusion

It is a tough time for senior managers. Customers increasingly view products and service lines as commodities and place pressure on prices. Business mergers and employee layoffs are ongoing, and there is a limit that is forcing management to come to grips with truly managing their resources for maximum yield and internal organic sales growth. A company cannot forever cut costs to increase its prosperity.

It is imperative financial executives in 21st Century organizations provide management with comprehensive and sound decision-support information, guide them in formulating an effective business strategy, and provide the means of linking that strategy to execution through an effective EPM system. That’s what financial planning and analysis means today. It is the financial arm of a company that adds value by providing it with the information it needs to thrive and grow in a worldwide, hyper-competitive business environment.

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Douglas T. Hicks, CPA, CMC, is president of D.T. Hicks & Co., a consulting firm concentrating on the decision costing needs of small and midsize firms.