In this article we will look at the different methods an organization can use to set...
Balance Your Financial Planning
In 1992 a professor named Robert Kaplan and a consultant named David Norton created a measurement system called The Balanced Scorecard. A reason for creating The Balanced Scorecard was to go beyond financial statements in measuring what businesses do in order to improve performance.
Going beyond financial statements meant adding perspectives, points of view, for evaluating performance. Evaluating performance through The Balanced Scorecard is measured not only from the perspective of finance (Financial) but also from the perspectives of customers (Customer), processes (Internal Process), and employees (Learning and Growth).
The measurement system known as The Balanced Scorecard has received both praise and criticism however The Balanced Scorecard has established an important role in Financial Planning which is using different perspectives to think about how to accumulate wealth.
Financial Planning through the Financial perspective seems to be a given in Financial Planning but what this perspective can do is establish how performance will be measured through money. The measurement of money is achieved in a number of ways. Here are some examples of measurements that I have seen and used in my professional life:
- EBITDA (Earnings Before Interest Taxes Depreciation Amortization): I have used this measurement when working with an adviser to entrepreneurs who used this measurement to determine the valuation of startups.
- Return on Equity: I used this measurement as a student in graduate school; a professor who taught accounting courses I took used this measurement to help me and other students assess the financial performance of corporations.
- Free Cash Flow: This measurement is used by investors like Warren Buffett to assess the financial health of businesses by subtracting capital expenditures from net cash provided by operating activities.
- Economic Value Added (EVA): This measurement assesses financial health by subtracting the firm’s cost of capital from the firm’s operating profit.
- Return on Investment (ROI): This measurement assesses financial performance by focusing on the relationship between the amounts of income earned from investments in assets to the costs of assets incurred.
- Net Income: This measurement, perhaps the simplest and most traditional, assesses financial health by subtracting expenses incurred from revenues earned.
Based on the above-listed examples and others that exist people have a number of ways to measure performance from the financial perspective. Here is where the expertise of an FP&A professional is key. The expertise of an FP&A professional can provide insights into the strengths and weaknesses of measurements which in turn can be managed in a way that maximizes the positive and minimizes the negative of seeing the performance of businesses from the financial perspective.
Once measuring performance from the financial perspective is established Financial Planning should focus on balancing measurement based on money by thinking about how to accumulate wealth from the perspectives in The Balanced Scorecard.
The customer perspective focuses on what people see from the products or services they purchase. People can tell us a lot from what they see in the products or services they purchase. Perhaps the most important part of what they see is the characteristics of what is sold; examples of characteristics are accessibility, competence, courtesy, durability, and innovation. What The Balanced Scorecard provides is an opportunity to measure what people see from the products or services they purchase.
Here are some examples of measurements that can help people evaluate the performance of businesses through the eyes of their customers:
- Percentage of Repeat Customers
- Brand Recognition
- Customer Retention
- Percentage of Customers Who Would Recommend Product
- Response Time per Customer Request
Measurements like the ones listed above and others that apply to the customer perspective are an important part of Financial Planning. Businesses need customers in order to exist and customers will help businesses exist when customers see the value in buying what businesses sell.
It is the value that customers see which affect revenues as well as cash flows which affect what is being measured from the financial perspective. So it’s natural for wanting to acquire insights into what customers see and that can be accomplished with measurements.
The value customers see in the products or services that businesses sell does not come out of nowhere. The value customers see in the products or services that businesses sell comes from how businesses satisfy these expectations. How we can see the ability of businesses to satisfy the expectations of customers can come from looking at businesses through the internal process perspective.
Internal Process Perspective
The internal process perspective is a point of view that applies to a company’s value chain; a value chain represents activities that provide products or perform services. Here is where Financial Planning is critical. People need to think about how to accumulate wealth based on how products are being provided or services are being performed.
Thinking about these tasks can help determine whether the business is in sync with the marketplace. The Balanced Scorecard provides a framework that can help people think about how the activities that provide products or perform services are supporting what customers see and strengthening financial health.
Here are some examples of measurements that can help people evaluate performance through the activities inside businesses:
- Amount of Setup Time
- Percentage of Defect-Free Products
- Labor Utilization Rates
- Waste Reduction
From these and other measurements people can seriously think about the effort that is going into what is sold. The keyword is effort. Effort does not come from processes alone, effort comes from the people who create and execute these processes. So is it necessary to think about how people are engaged in processes that satisfy customer expectations which strengthen financial health? The answer is yes and that can be accomplished by seeing the business through the eyes of its employees.
Learning and Growth Perspective
The learning and growth perspective focuses on the ability of companies to develop and retain its employees. Skill, the ability to do something well or expertise, is the driver of action. Action creates, maintains, and improves processes that provide products or deliver services
Not developing skills or losing people who have skills can cause a chain reaction that ultimately leads to a business no longer existing. As a result, Financial Planning should incorporate this element of the Balanced Scorecard to protect businesses from the threat of extinction.
Here are some examples of measurements that can help people evaluate performance through the eyes of a company’s employees:
- Percentage of Employees Leaving in Less than One Year
- Number of Cross-Trained Employees
- Ethics Violations
- Training Hours
- Reportable Accidents
These and other measurements should stimulate thinking about the importance of employees. Even though companies outsource work or utilize technology they will have employees. These employees, directly or indirectly, will have an effect on the activities that go into the provision of products or the delivery of services. This effect cannot be ignored. So rather than addressing negative effects after they happen why don’t people become proactive by looking at their businesses from the eyes of their employees?
Innovation, new methods or ideas, is necessary for survival and FP&A must look at innovation in order to survive. FP&A professionals must remember however that situations exist which don’t require the reinvention of the wheel. When it comes to Financial Planning, the process of thinking about how to accumulate wealth, a question an angel investor asks entrepreneurs comes to mind. The question is
I don’t care what your idea is, I want to know how I’m going to make money?
An answer to that question can come from achieving balance in Financial Planning.