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The new New Economy Analyst
Report – May 28, 2003
Juergen Daum’s new New
Economy Best Practice service
©2003 Juergen Daum. All rights reserved.
Finance Transformation: The evolving role of
the CFO and the need for a new corporate financial infrastructure
News categories: The
New Economy Economics, the new role of finance, Finance and Accounting,
Performance Management and Controlling, Investor and Stakeholder Relations
Globalisation,
volatile capital markets, ever-increasing shareholder expectations, and – in
the wake of the Enron and WorldCom debacles- growing demands for greater
corporate accountability and improved governance procedures are remaking
today’s businesses. But while the CEO remains a key player in the corporate
equation, another player is now beginning to assume unprecedented importance:
the CFO.
The CFO – even
more than the CEO – is quickly becoming the person upon whom many boards now
depend for answers. Although CEOs are still firmly piloting the ship, most of
their orders of late seem to be landing on the CFOs desk. In a recent survey of
500 senior executives conducted by Deloitte Consulting and Business Week (see
below: “Additional Resources”) demonstrates, that the CFO is pivotal to
restoring public trust and that he or she has to serve as an important bridge
between the CEO and the board on governing matters. In addition the CFO must
expand the role of economic corporate steward, daring to dissent when
necessary, and must serve, in his or her strategist role, the CEO with
effective insights on the affairs of the company and its businesses. In a
survey of CFO Europe, 71% of the CEOs reported, that their CFO is their closest
business confident. This gives CFO’s today enormous clout in their
organization.
But the new
CFO-mission is not an easy one. CFOs have to fulfil various, partly
contradicting tasks in parallel. They have to
§
Re-establish corporate trust and business integrity
§
Protect the company’s bottom line
§
Enable for profitable growth and shareholder value creation
§
Do more with less (increase the efficiency and quality of
financial operations)
Restoring corporate trust and business integrity through a
world-class corporate financial infrastructure
After a series of
corporate scandals (Enron, WorldCom etc.) trust of investors in corporations
has sharply declined – a fact that is threatening a company’s capability to
finance its activities and ultimately, its “license to operate”. The Chief Financial Officer (CFO) and the
finance function is playing a leading role in restoring corporate trust and
business integrity. Assuring tight financial integration and accountability to
enable the company to meet the new corporate governance requirements and
establishing compliance with new regulations (IAS, Sarbenes-Oxley Act, other
new corporate governance standards such as in Germany) represent major tasks
for CFOs today. It requires them to
improve and extende the corporate financial infrastructure.
Protecting the bottom line through extended transparency and dynamic performance management
After the economic
boom of the 1990s, when most companies focused on top line growth at nearly any
cost, many corporate executives are facing today, in the actual global economic
contraction, a major challenge: declining sales figures force them to reduce
costs in order to protect their bottom line. This is putting the CFO and his
finance team into center stage. But today’s highly competitive and dynamic
markets require companies to do intelligent cost reduction - cost reduction
that is not hurting their existing growth potential, intangible assets such as
human capital, intellectual capital or customer and business partner relations,
and that is not putting their future at risk. For this, corporate executives,
business managers and controllers require extended information about current
performance and about future risks and new business opportunities – beyond the
transparency the traditional P&L and Balance Sheet delivers. CFOs must
react by providing new analytic tools that deliver not only accurate and timely
information on current financial performance, but also on its drivers across
the entire business. One of the main objectives is to enable for more accurate
forecasts, not just of financial performance but also of the underlying
business drivers. Rolling financial and business forecasts are forming the
foundation for dynamic performance management that help managers and executive
to achieve their company’s performance targets in a dynamic business
environment.
Enabling for profitable growth and shareholder value creation in a challenging business environment
Today, value
creation strategies based on M&A activities, as applied widely in the
1990s, have come to a limit: when assets exchange at full market price no value
added is created. Still in some cases M&A and financial dealings can create
value, but only if combined with accuracy and discipline in the evaluation and
integration phase. For most companies however, shareholder value today comes
from internally generated growth and/or resource, cost and capital efficiencies.
But efforts in both areas work out only, if applied continuously - quick wins
are exceptions. This also requires accuracy and discipline – unique
characteristics the CFO brings to the table in the corporate management team.
So it is no wonder, that CFOs are involved more than ever in (the more seldom)
M&A activities, are playing a leading role in strategy planning and
execution, and in long term efficiency and productivity management. A best
practice in strategy management and corporate performance management is a
portfolio management approach that takes into account the entire bandwidths of
risk/return and all operational value drivers on the business unit level below.
This requires much more transparency for corporate management of the business
units risk/return prospects and their value drivers than the traditional
budgeting and financial reporting approach. The CFO is called to establish this
transparency and to implement the tools and procedures to enable top management
to make better trade-off decisions and to make the link between corporate and
business units more productive.
Also the ability
to manage for internal growth requires a deeper cut into the business: CFOs
have to help business mangers to understand the economics of their businesses
in order to create profits and value. For instance, they have to help them to
understand customer requirements from an economic perspective and to select the
appropriate service levels and products accordingly (as a result, customers
requiring low service might be guided to buy commodity products only online).
Resource and cost
efficiency is usually the result of continuous optimization work rather than of
a one off event. CFOs have to establish and implement the procedures and
systems to make that happen – for instance through continuous benchmarking as
part of the performance management process. And finally CFOs have to make sure,
that created value is properly communicated to the financial community so that
it can be recognized by outsiders and is reflected in the company’s share
price.
CFOs under
pressure
As a result, the
CFO, usually the senior corporate executives with the heaviest workload
already, finds his agenda even more extended and the pressure is increasing.
But in order to be able to fulfil their new tasks, implement the required
financial control, assure current and future financial performance, and reduce
cost of finance and increase at the same time the productivity of finance, CFOs
have to depart from how they ran their finance operation in the past. In
addition, many companies have weaknesses in their existing finance operations.
Many companies have significant weaknesses in their
financial operations
Many companies
have focused their investments for business process and systems
improvements/innovation in recent years on business operations (CRM, SRM, SCM).
As a result, most companies have significant weaknesses in their financial
operations and most CFOs are concerned to catch up:
§
They have little confidence in their ability to predict future
financials performance and liquidity
§
They are using outdated, inefficient and not integrated budgeting tools
§
They have extended closing periods
§
They have high levels of financial working capital bound in accounts
receivables and bank accounts
§
They have high processing and service costs
According to a
recent benchmark study of The Hackett Group, cost of world-class finance
organizations is 2.4 times lower than at average firms (0.43 vs. 1.05 percent
of revenue). This is creating a tough benchmark for many CFOs.
The
CFO’s strategic finance transformation project
Whereas
average total finance costs as percent of revenue remained at the begin/mid of
the 1990s still at a level of 2%, this number declined until begin of the new
century to 1%. The actual world-class rate of about 0,5% marks the average for
mid/end of this decade and represents for CFOs the bottom line of what will be
accepted in 5-7 years by their CEOs and boards.
Figure 1: Today’s CFO mission and the need for the transformation of
finance
To
achieve these type of cost efficiency and cost savings without reducing the
quality and effectiveness of financial services (the business will require even
more quality in the future!), CFOs have to apply a different strategy than just
relying on incremental improvements in the day-to-day work processes of their
financial operations. In order to reduce cost and provide more and higher
quality financial services at the same time, they need a new conceptional
approach to finance. To make it happen, it requires a long term effort and
transformation project that reduces on a continuous basis over the next couple
of years not only variable costs but also structural costs. It requires them to
rethink finance from an organizational, process, system and people
perspective.
How
to make it happen?
How
can CFO’s achieve significant cost savings and provide high quality financial
services at the same time?
Everything
starts with better concepts. CFOs first have to come up with more intelligent
process and organizational concepts for finance and then they have to find ways
how to depart from where they are today in order to realize quick cost savings
that free up resources needed for the next step. Best in class companies do not
spend more on technology than average companies to achieve cost efficiency and
high quality financial services. In fact they spend even a little bit less (see
figure 2). The key to this is: more intelligent business, finance and IT
concepts whereas business/finance concepts have to be the starting point – not
technology.
Or,
as Peter Drucker phrased it:
“A
new information revolution I under way. […]. It is not a revolution in
technology, machinery, techniques, software or speed. It is a revolution in
CONCEPTS.
So
far, for fifty years, Information Technology has centered on DATA – their
collection, storage, transmission, presentation. It has focused on the “T” in
“IT”. The new information revolutions focus on the “I”. They ask “What is
the MEANING of information and its PURPOSE?”
(source: Peter
F. Drucker: Management Challenges for the 21st Century, New York 1999)
Figure 2: Achieving financial efficiency by applying more intelligent
finance and IT concepts – but not necessarily larger IT budgets
Fixing
the IT landscape problem in order to create the foundation of the new financial
infrastructure
Already, most finance functions have made a
significant shift – driven by investment in information systems and shared
service centers – toward being less resource intensive, more efficient teams,
particularly in the area of transaction processing, allowing increased emphasis
on decision support. In the future, finance will be even leaner. With many
tasks delegated to business managers or handled by shared service centers or
external outsourcers, the finance staff will act as coordinators and offer
higher value, adding more strategic services. Standardized, integrated
processes and systems will be embedded within the business, and they will be
available globally to users who can operate them without needing to be aware of
where they are located and maintained. The critical role of decision support
may be fulfilled primarily by managers outside finance. Finance professionals
will adopt a new training and coaching role to transfer appropriate skills and
techniques. The result: finance will become more virtual (see figure 3).
When CFOs and their finance staff have outlined that
vision and defined the appropriate programs they are often confronted with a
critical problem: the existing IT landscape does not keep pace with this
vision. It even does not allow to move forward and to do the first step,
because the grown IT landscape with too many different systems and a very
heterogeneous portfolio of incompatible applications, data structures,
interfaces etc. is binding to much IT resources. As a result, IT is not able to
support the new finance initiative in a satisfying way. So many CFOs have
agreed with their CIOs to fix the IT system landscape first. The objective is
clear: to consolidate ERP (Enterprises Resource Planning) other critical
systems in the company in order to safe maintenance costs (reduce TCO – Total
Cost of Ownership) and to leverage this process to consolidate also the finance
organization, finance processes and reduce the number of different processes,
data structures and interfaces. The benefit can be significant. According to
AMR Research, ERP consolidation can lead to an overall decrease in IT
maintenance costs of 25%. Other sources report
costs savings of even 30-50%.
Figure 3: Moving to a new financial infrastructure require companies to
fix their existing IT landscape first
Case
study of a global consumer products company
The CFO of
this consumer products company with global operations defines the mission of
his finance functions as follows:
§
Optimize Shareholder Return
§
Ensure Corporate Governance
§
Provide best in class financial services
With the
change of his finance organization to a more global role and to global
responsibility not only for general finance guidelines, but also for execution,
the CFO found it necessary to redefine the finance function. End of 2000 he
started a finance transformation program that will help the finance
organization to achieve until 2005 the following goals:
§ General:
Consolidate financial systems from a number of 15 in America, 26 in Europe and
54 in Asia (a total of 95 systems) to only 1 mySAP Financials system per region
(in order to harmonize accounting processes and increase efficiency)
§ General:
Leverage this system consolidation to consolidate the
finance organization from 125 different F&A units globally to a total of
only 28-30 F&A lead units
§ Accounting:
harmonize financial semantics and structures (chart of
accounts, of financial, management and asset accounting, of closing processes
and other financial processes) from a variety of 280 different approaches
globally to only 1 global standard (in order to speed up processes, reduce
redundant work, to increase efficiency, and to provide an accurate financial
data base for timely decision support)
§
Corporate Controlling / Decision Support: Implement
one global reporting and planning tool (SAP BW/SEM) that is integrated tightly
into the rest of the financial infrastructure, but that is open at the same
time to capture data from other sources as well (in order to speed up
reporting, planning and forecasting cycles, to increase accuracy and to enable
for recognizing early warnings of actual and strategic weaknesses – “from
budget review to real time value adding business analysis”)
§ Area
finance/treasury: move to an in-house bank concept
(consolidate treasury/cash management and payment transactions), full
automation and web enabling of treasury transactions, global liquidity and
financial risk management (in order to reduce financial working capital and to
increase efficiency and effectiveness in finance/treasury)
§ Area
of capital market communication / investor relations:
address the right investor target group, permanent and proactive communication
with capital markets (in order to unlock value drivers and to “crystallize the
intrinsic value of the company in its share”)
§ Others:
serve as full service provider in M&A activities; optimize tax expenses and
rates through an efficient global tax policy and strategy (“from local
optimization to a global tax strategy”); improve internal auditing by adding
value to the process examined and by ensuring compliance with established
policies
Summary
Most finance operations are
not prepared to fulfill their new tasks for their companies, that is to assure
corporate governance, continuously reduce costs related to financial activities
and provide high quality services at the same time. They are specifically not
able to support the business in a proactive way, that is to anticipate future
business needs and to start today to implement required processes and systems
accordingly, because they have significant weaknesses in their existing
organizational, process and system design that ty to much resources to the
daily operations. The result: these resources are not available to support the
transformation process and to work on the related programs.
Figure 4: A
finance transformation projects is first and foremost not an IT project – it
starts and ends with business, finance and organizational concepts
In contrast to what may IT
people think, a finance transformation projects is first and foremost not an IT
project. Everything starts with improved business, finance and organizational
concepts and IT must enable. Nevertheless, an important first step is often to
improve the efficiency of the existing IT landscape that supports financial
processes in order to free up IT resources that are required for the next steps
in the transformation process (see figure 4). Prominent strategic topics that
CFOs want to tackle through the transformation process are (see J.D.’s Best Practice Channel – Finance):
§
Evaluate the impact of the business architecture evolution
of their companies on the required design of the finance operations and related
shared services and act accordingly
§
Design and implement the performance management system for
the future
§ Streamline the
Financial Supply Chain
Additional Resources:
J.D.’s Best Practice Channel – Finance
Recent CFO research results:
Deloitte
Consulting/Business Week (2003): Empowering the CFO – Key Findings from the
Deloitte Consulting / Business Week Survey of Corporate Executives, March
7, 2003
http://www.dc.com/obx/library/media/empowering_the_cfo.pdf?seshid=58d55cd6292a62f58f0f411344ec6e06
The
Hackett Group (2003): New Research Finds Major Efficiency Gap Exists in
Corporate Finance, press release, Wednesday February 19
http://biz.yahoo.com/prnews/030219/nyw007_1.html
Literature on CFO / finance
transformation:
Juergen H. Daum: Intangible Assets
and Value Creation, Wiley 2002
More about New Economy Economics and Management
Best Practice in general, and about other related topics will be continued here
in this new New Economy Analyst reports (see for
example this report).
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