FP&A Trends Survey 2023: Define the future of FP&A
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Does your organization view Finance as a business partner, one who provides value-added insight that helps grow the business? Or does the business tend to perceive Finance as the constant “deal-breakers”, who routinely throw up hurdles and are quick to say “no” anytime a business expert has a new idea or growth initiative?
As Finance leaders, we can’t expect the business to view Finance as value-added partners if we can’t put a stop to this often-inaccurate stereotype in advance.
So where should we start? The answer lies in better communication along with greater transparent and objective measurements that can be easily understood and used by all.
In other words, we need a common language that both Finance and the business can speak, without trying to turn Finance people into business experts nor business experts into Finance people (a common mistake in Financial Business Partnering).
So, what is this common language? The answer is Cash Flow.
In the finance world, we all know that Cash is King. However, in more recent times we seem to have gravitated to the viewpoint that the analysis of Cash Flow is an academic rather than a practical exercise.
In reality, this could not be farther from the truth. Take for example a small business. If that owner is going to succeed, chances are he/she has a pretty good understanding for where cash is both generated and spent. Yet, these same small business owners are far more likely to be business experts rather than Finance focused individuals.
However, in larger organizations, employees tend to lose sight of Cash Flow. Take, for example, an employee working in Customer Support. Over the last few years, we’ve probably all experienced both good and bad customer support. In my experience, the best customer support calls are with the employees that value your business and by this, I mean they can tangibly calculate the value of keeping you as a reoccurring customer. Simply put, breaking that link to Cash is a recipe for failure.
When most people think of Cash, they think of Cash Flow Statements. This often requires an understanding of Indirect Cash Flow vs Direct Cash Flow, as well as a good understanding for the breakdown of Operational, Investing or Financing activity.
This can make anyone’s head spin, but what’s really important is far simpler and can largely be addressed by answering three simple to understand questions.
If the answer is yes, to all three questions then you have a legitimate value creation opportunity that deserves a proper discussion/debate.
As you can tell, there is nothing academic about these questions. Anyone with a business idea can and should be required to answer these questions. Of course, not everyone will share the same assumptions or perspectives, but that’s where the financial business partnering really comes into action.
So, how do we start convincing the business that Cash Flow is the single most important metric after we’ve spent so long convincing them of other less important metrics (that have done very little to spur on effective financial business partnering)?
Below are 7 reasons why the business should adopt cash flow as the definitive language for justifying growth and measuring success.
One major benefit of making Cash Flow your primary metric is that it does not require any accounting knowledge. As we all know, accounting rules are complex. They differ by jurisdiction and by type of business and let’s not forget that they are always susceptible to rule changes. This makes it impossible for business experts to keep up.
Of course, I’m not arguing that the accounting isn’t important or that it doesn’t have to be done at some stage, but it should not be a driving force in the Financial Business Partnering discussions. This is like trying to engage in a debate with someone from another country in their language. They are always going to have the upper hand in driving the conversation, regardless of the fact that both parties have important things to say.
One of the reasons why Cash Flow is so useful is that it is all-inclusive (it includes both the Income Statement and the Balance Sheet). This avoids the problem of jumping around from financial to financial only to fall short on one or two metrics that are often attributed to killing the deal and frustrating the business expert.
With Cash Flow, there is one ultimate measurement to evaluate. Of course, you can always drill down into the details from there, but you get a holistic view from the start. This puts the analysis in perspective. Maybe your expense ratio is higher than you would expect, but if the cash inflow is strong, then the business opportunity or strategy might be totally justifiable.
Businesses are shifting more and more to driver based planning. As a result, organizations should be better positioned to understand and react to changing business conditions. After all, it’s all about connecting the dots.
However, a common pitfall to driver based planning is to focus on drivers that don’t directly drive sustainable growth in Cash Flow. I like to call this “Smiles/Hour” mentality.
Of course, operational drivers are extremely useful, but they should ultimately always be linked to sources and uses of cash. This is not always easy to do, but I think the exercise is well worth the effort. In many cases, you might find it impossible. In that case, you may want to ask yourself why? Is your business model overly complicated or are you relying on poor/meaningless drivers?
Some people may be quick to argue for a few easy to understand ratios as top indicators for performance. Ratios such as Return on Investment (ROI) and Earnings Per Share (EPS) are some of the first to come to mind.
The fact is, ratios usually suffer from two significant problems. Firstly, they often rely on the same accounting problems we already discussed, but secondly, they usually suffer greatly from timing issues. Take, for example, a simple ROI formula. If investments are made today and the income is generated later, the ROI will initially look unattractive as the numerator will be unchanged while the denominator will increase (thus reducing ROI).
Common ratios may seem logical for Finance minds, but they can cause a great deal of confusion and misinterpretation that can be disastrous for business experts to fully grasp.
Due to resource constraints, organizations are forced to make business decisions based on comparing two or more business opportunities. What happens when you’re comparing two alternatives that look very different on paper? For example, should we implement a new cost savings measure or look to fund additional growth opportunities within a specific business unit? What is the justification for doing one or the other or both?
Cash Flow analysis enables the business to justify which projects should be undertaken based on highly comparative metrics. This provides scrutiny over pet projects that often get pushed through based on persuasion and politics alone.
Asking the business to be an active participant in the analysis of alternative opportunities is a great way to ensure that the best projects and ideas get green-lighted. Alternatively, it’s also a great way to ensure that business doesn’t waste their time engaging in projects that don’t really add value.
Let’s face it, we all want to improve our ability to think more strategically, yet we all seem to have slightly different definitions of what strategy means (let alone how to measure it). Broadly speaking, most people would agree that strategy involves the long-term allocation of business resources in a way that optimizes shareholder value.
That being the case, we can measure strategy by simply analyzing the upfront cash investment against the likely future cash returns at a perceived level of risk.
These three measurable elements are at the heart of every major business decision, regardless of whether you are buying some shares of stock, starting a business or evaluating a capital project.
Unfortunately, many companies will focus all their efforts on being more operationally efficient, in an attempt to eliminate risk and time-to-payback, but in doing so will inevitably run the risk of missing out on the next big thing due to the lack of strategic investment.
Of course, no one can accurately predict the right assumptions all the time, but proper financial business partnering will ensure that the right communication is happening. Enabling the business and Finance department to engage in the more meaningful strategic dialogue is vital for every business.
Ultimately, the only way Cash Flow is going to permeate business culture is if it directly benefits the individuals responsible for using (or shall I say speaking) it.
The Cash Flow ecosystem works well because, if implemented correctly, it can simultaneously benefit both the company and its employees, enabling everyone to work together to pull in the same direction.
This is achievable by tying employee compensation to sustainable growth in Cash Flow. Currently, this is common practice for senior executives, but it should be actively rolled down to lower levels throughout the business, eliminating short-term thinking wrapped around complex accounting treatments.
By educating the business on the importance of Cash Flow, we are creating value trees throughout the organization that increases value for the shareholders while at the same time rewarding the individuals responsible for creating it.
Cash Flow (or more specifically Discounted Cash Flow in this case) is the basis for calculating shareholder value. Yet, business experts only need to comprehend Cash Flow 101 to understand that they are creating value for the business. In other words, engaging the business in discussion and debate around the ideas and initiatives that create maximum value is what’s most important. Establishing an actual value for the business need not be a collaborative exercise.
Cash is King, it always has been and it always will be. Hiding from it, marginalizing it or trying to eliminate it from your business model is a recipe for disaster.
By building a business culture that takes a “Cash Flow first” approach to analyzing and measuring opportunities is the pathway to success for virtually every business.
Despite the overwhelming justification of Cash Flow over other forms of measurement, I’ll admit that it is still just one method of many. Yet, what sets Cash Flow apart is its purity and simplicity (everything is either a cash “in” or a cash “out”). It’s for this reason why Cash Flow must be the ultimate language for financial business partnering. Forward-looking assumptions and unified perspectives are always going to be difficult to arrive at, but the best financial plans will always arise out of a healthy dose of communication.
As Finance leaders, we need to do a better job of leading efforts to educate the business on the importance and simplicity of Cash Flow. In a world where we are being told to be better “storytellers”, we must realize that Cash Flow is a fact, not fiction. Let’s lead with the simple truth.
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