Monday, November 1, 2010

Understanding Your Cost of Finance



Depending on the part of the world you live in, what keeps the finance executive up at night can be vastly different.  For those in the US, making sure you maintain market share is paramount.  For those in APAC, finding and retaining top talent without overpaying might be at the top of your list.  But a common theme for all finance execs is making sure your organization is operating as efficiently as possible.  Undertaking a cost of finance study can help to provide objective measures in determining if you are getting the most out of your finance team.
The objective of a cost of finance assessment is to benchmark a company’s finance function relative to its industry standards and organizational size and to quantify the cost of the finance function, based on FTE activities.  The assessment should identify strengths and weaknesses that exist within the finance function and produce an actionable plan for improving areas where the company is operating below the agreed upon standard. 

Agree on the scope of the review

The first step in the review is to agree on the scope.  The term finance function should be treated broadly and all functions (whether they report to the CFO or not) should be included if time and budget allow.  Finance areas typically considered include:
  • General Accounting
  • Risk Management and Compliance
  • Treasury and Cash Management
  • Corporate Planning (annual budget, long range planning)
  • Corporate Strategy
  • Corporate Development (M&A)
  • Business units
  • Payroll
  • Tax
  • SOX - Internal Controls Process
  • Accounts Payable
  • Fixed Assets
  • Project Accounting and Reporting
  • Billing and Accounts Receivable
  • Finance IT

Process Documentation

Each process for the in-scope areas needs to be documented.  If you are a public company subject to SOX or other controls-based regulation, then it is likely that you can utilize your controls documentation as a baseline and supplement where needed.  Regardless of where you start, you will need a list of each task performed within each major activity of the finance function, based on FTE time allocation. 

Metric/Measure Development

Once you are clear on the tasks that each function performs, you should develop a list of metrics/measures that you will include in the study.  They need to be relevant and you need to be able to capture the data.  Many databases and studies exist to serve as your benchmark and these should be referenced for industry standard metrics and measures. 

Examples of metrics include:
  • Finance Costs as a % of Revenue
  • Revenue per Finance FTE
  • AP Cost as a % of Revenue
  • % of AP Invoices Automated
  • Total AP Invoices processed per FTE
  • Total AP Invoices Lines processed per FTE
  • Average Salary in AP Department

While a robust database is critical to this type of analysis, it is not without certain limitations.  Differences such as organization structure, process design, technology, and industry may drive disparity in both entity performance and the interpretation of relative performance.  Despite efforts of practitioners to structure data collection efforts in a consistent manner, the unique circumstances of each participant will influence this process, in turn influencing the outcomes.  Make sure that the differences have been normalized before making decisions on the results. 

Data Capture

Once you are clear on your metrics, you can begin data collection.  The data will need to produce the metrics you have chosen above.  While this may include some uncommon data points, most of what you will be collecting includes:
  • Complete financials for the entity
  • Full Time Equivalents (FTE) working on the process
  • Key transaction volumes (e.g. number of invoices) – split between manual and automated
  • Costs applicable to the process – broken down by salary-related, direct on-cost, IT cost, outsourcing cost, corporate overhead, etc.
  • % estimates for non-value add, errors & defects & SLA performance
  • A few key process metrics - e.g. % credit notes, days for month-end close

Analysis, Results and Recommendations

After you have collected all the data, you can begin the analysis of the results and craft the recommendations.  Understand that creating a world class finance organization does not come without cost.  When reviewing metrics, look for areas in the process or organization where you are significantly below the agreed upon standard.  Determine the best approach or a prioritized listing of approaches to resolve the gap.
  • Is a lack of automation to blame?  Maybe a system should be implemented.
  • Are salaries too high?  Maybe a shared service in a cheaper location is in order.
  • Are there too many errors?  Maybe a training program is needed. 

When identifying solutions and creating the business case for any major changes, remember to calculate the cost savings generated by the improvement.  In many cases, the easiest improvements are the ones that end up being self-funded.  Once you understand where improvement is needed, the possibilities of how to improve are limited only by your imagination and budget. 


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