An article that describes how to develop critical KPIs for the purpose of alignment of operational goals to financial goals-from TCS Consulting

Connecting the Dots: Aligning Financial Goals with Operational Efficiencies

White Paper

Business Process Services

Shirley Kamath

Shirley is a Chartered Accountant and law graduate and is currently managing a corporate initiative for 'Simplification of Internal Processes' at Tata Consultancy Services (TCS). Backed by her expertise in Finance and Accounts and experience in IT, she has successfully led many transformation projects. She has also been instrumental in

TMdesigning FORE , TCS' transformation framework. Shirley has over 20 years of experience spanning both IT and BPS, and her areas of expertise include ERP implementations, and process and technology consulting.

About the Author

As businesses face greater complexity and uncertainty in their economic environment, every function needs to rethink its role and realign its objectives with organizational goals. This is especially true for the finance function. Today, the role of finance extends beyond transaction processing, accounting, and reporting. CFOs are being called upon to become strategic business partners who support and drive growth. They are responsible for defining and applying clearly defined objectives and milestones that link operational efficiencies with business outcomes.

This white paper outlines the importance of being part of the 'big picture' in building an effective finance function, and how finance functions need to translate financial objectives into clear operational targets. It recommends a two-pronged approach – top-down and bottom-up – to create and sustain value for the organization. The paper illustrates how CFOs and financial executives can align their objectives with operational efficiency.

Abstract

Contents

1. Introduction 5

2. Aligning financial goals to overall business goals 5

3. Building a finance function on a strong foundation 5

4. Making the connection: Linking financial and operational performance 6

The top-down approach to decision making 6

The bottom-up approach to execution 7

5. Scenario: Optimizing working capital 7

Using the top-down approach to identify factors impacting working capital 7

Using the bottom-up approach to identify a solution 8

6. Creating a backdrop for greater financial and business alignment 9

7. Conclusion 10

1. IntroductionThe objectives and goals of the finance function have evolved over time, and today it plays a critical role in shaping the overall business strategy. Finance is not only expected to offer transaction-processing, control, planning and financial reporting, but also to enable decision-making activities for the business. Therefore, in order to ensure collective success, CFOs cannot just focus on their functional role. They also need to consider operational and process-related challenges, along with the overall business impact of each decision. Such challenges include complying with the ever changing, increasingly stringent regulatory requirements, and aligning with a complex and dynamic business environment.

However, to achieve this balance, finance functions will need more than just the support of efficient transaction processing systems. CFOs need to arm their functions with relevant and timely information and frameworks for making strategic decisions, and to identify operational opportunities with quick actionable insights.

2. Aligning financial goals to overall business goalsIn the current economic and business scenario, CFOs are no longer seen as only controllers focused on recording and reporting numbers, but as strategic stakeholders in the organization. Thus, CFOs are required to understand their organization’s strategic goals and align them with their functional objectives. This alignment is imperative in order to direct employees to realize mission-critical objectives through the right operational approach – in effect operationalizing the goals.

To effectively operationalize business goals into financial goals requires the organization and the CFO to collaboratively design the right alignment practices. This requires a two-way flow of information and understanding — while business planners must evaluate the impact of the strategy on finance, CFOs need to help middle managers and front-line associates understand how their short-term targets translate into strategic impact for the organization.

3. Building a finance function on a strong foundationTo create an effective finance function that drives sustainable value for the business, there are no ‘ready-to-use’ or ‘one-size-fits-all’ solutions. While requirements may vary across organizations, there are some fundamental questions that must be answered to design the right solutions and derive the targeted benefits:

n Are the vision, goals, and value drivers of the organization well defined?

n Are the performance measures of the finance function (business KPIs or metrics) clearly defined and communicated?

n Are the performance measures linked to the goals and drivers of the organization?

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n Is there a process to regularly capture and analyze the trends in operational performance?

n Are the performance measures regularly compared and benchmarked with peer groups and industry leaders?

n Is there a regular mechanism to review industry trends and leading practices to identify opportunities to improve performance?

The suggested approach in this paper helps organizations answer these questions affirmatively and derive more value from their finance functions.

4. Making the connection: Linking financial and operational performanceThe performance of the finance function is inextricably linked to that of the organization; financial decisions cannot be made in silos without considering the impact and influence on operational goals. It is therefore critical to identify financial performance measures to balance strategic priorities and operational needs. We suggest a two-pronged approach — a combination of top-down and bottom-up methods. Correlating the objectives derived from the top-down approach to actionable requirements derived from the bottom-up approach helps translate financial objectives into operational targets for the business.

The top-down approach to decision making

This approach starts with a sound understanding of overall organizational goals and subsequently the operational requirements to achieve them. Decision makers from finance functions need to:

1. Establish the correlation between financial goals and process performance — in other words, establish the business metrics. For example, the business may need to improve liquidity management to meet the goals of optimizing working capital and improving cash flow.

2. Identify key operational metrics by establishing a correlation between the metrics and operational targets. For example, the key metrics that impact working capital and cash flow are day sales outstanding (DSO) and day payable outstanding (DPO). This helps zero in on the process areas that need to be addressed —invoice processing, disbursements (AP), billing, and cash management (AR). DPO is impacted by the percent of invoices paid on time; DSO on the other hand depends on the collection effectiveness index, which is the percent of unapplied payment.

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The bottom-up approach to execution

This approach assesses the processes that are impacted, and helps identify leading practices that can positively influence operational metrics. For this approach, decision makers should:

1. Identify the underlying high impact processes and establish a cause-effect relationship between the operational metrics and processes. In the above example, DSO is influenced by some of the back office processes pertaining to accounts receivable such as customer master maintenance, customer billing, collections, cash applications, and customer credit rating.

2. Leverage best practices that impact operational metrics to build a sustainable platform for driving business metrics.

5. Scenario: Optimizing working capitalConsider an organization trying to optimize working capital, which is an important indication of operational liquidity that impacts overall organizational performance. However, this metric might not mean much to teams handling accounts receivable or accounts payable operations. These employees may have little or no idea of how their work contributes to the organization’s net cash flow. The failure to understand such implications at the organizational level means that they view issues with payments receivable as simply a matter of delay — and not as a reduction in working capital.

Let’s apply the suggested methodology to this example.

Using the top-down approach to identify factors impacting working capital

As a first step, we need to monitor DSO and DPO to optimize working capital through daily operational metrics. The next step involves the identification of factors driving DSO and DPO performance. Further analysis can help derive the operational metrics and challenges that impact DSO such as:

n Delays in billing

n Aging of receivables and delays in collections

n Inaccurate customer credit analysis or rating

DSO may also be influenced by metrics such as the percentage of:

n Bills raised on time

n Receivables past the due date

n Receivables past 90 days of the due date

n Bills under query

Figure 1 illustrates how operational metrics and challenges can be derived from strategic goals.

Using the bottom-up approach to identify a solution

Having understood the underlying metrics and challenges that impact working capital, the next step would be to derive solutions on how to influence them positively. This requires an analysis of the performance linkages between operational measures and finance goals. The results of the analysis can then help make the right decisions and identify solutions that can be applied bottom-up for achieving the overall goal.

In this instance, we can formulate four solutions that are likely to have a direct impact on operational metrics, and thus deliver greater business value:

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Figure 1: Deriving operational metrics for optimizing working capital

Strategic MetricsMetric aligned withStrategic goals

Business MetricsEffectivenessMeasure

Operational MetricsRelated to process

StrategicGoal (L1)

BusinessMetric (L2)

OperationalMetric (L3)

Accounts Receivable

%Bills under

query or on hold

TAT-Billgeneration

%Receivables>due date

%Receivables

>90 days

Daily Sales Outstanding

(DSO)% Bad Debts

Daily Bill Outstanding

(DBO)

OptimizeWorking Capital

Risk profiling

and customer

segmentation

Bill processing

realignment to handle

surges during

the month

Automatic processing

of dunning

withalerts

System generated

aging analysis/ probable bad debts

Stucture

Procedures Policies

Onboarding

Process Technology

People Controls

Best practiceslevers and enablersto drive performance

Analyze performance linkages from business goals to operational measures

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Solution A: Risk profiling and customer segmentation: Helps improve the percentage of receivables collected on or before the due date

Solution B: Billing process realignment to handle surges during the month: Helps improve the percentage of bills raised on time and ensures that customer dues are received on or before the due date

Solution C: Automatic processing of dunning¹ with alerts: Ensures that reminders of payments due are sent to customers on time, and also helps reduce the number of outstanding payments

Solution D: System generated aging analysis and identification of probable bad debts: Enables managers to take necessary preventive action ahead of time to support targeted customers, reducing bad debts and the volume of outstanding payments

6. Creating a backdrop for greater financial and business alignmentAn organization may choose to apply any framework or methodology to achieve operational efficiency and functional effectiveness, but its success depends on having strong organizational support and a clearly defined roadmap for the future. In order to make the most of the approaches already outlined, organizations need to ensure the following:

Well-defined strategy: This consists of the mission, vision and goals, along with a clear definition of objectives and targets. Operations that are aligned with the strategy provide the foundation for driving greater value and achieving sustainable growth. It is equally critical to update the strategy as per market requirements and translate it into clearly defined goals² and objectives, both at the organization level and the unit level.

Strong executive sponsorship: Organizations should not underestimate the power of commitment and sponsorship from their senior leadership. A cross-functional team comprising finance and business unit heads ensures participation and also serves as a governing body to provide direction, secure funding, oversee progress, and resolve disputes.

Project based approach and key resource plan: It is important to drive the framework as a targeted project supported by a team with the right skill sets and experience. The team must also be well respected by their peers for faster acceptance across the function.

Change management process: Robust change management practices must be initiated by key stakeholders and supported by effective communication across all channels.

[1] Dunning refers to persistent efforts by lenders or suppliers to collect payment from borrowers or buyers

[2] Goals are broad statements that showcase what an organization would like to achieve, and are substantiated with objectives representing short-term targets.

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7. ConclusionIn the aftermath of the global financial crisis, finance functions have evolved and are poised to deliver greater value to business. But this also places immense pressure on CFOs to strike the right balance between strategy and operational performance. For this to happen, high-level goals must be distilled into operational targets with specific metrics that impact them. They must also identify issues, challenges, and best practices at the ground level, and connect them to the broader targets and goals of the business. The future is going to be all the more demanding, as finance functions become the building blocks for not only influencing, but also implementing and executing key strategic goals.

The requirements for striking the right balance between strategy and performance will differ from industry to industry, and organization to organization.

We recommend using a framework such as the methodology suggested in this paper, to correlate metrics at various levels of processes as well as across functions. This helps stakeholders understand the impact of each process and transaction, and gain insights on balancing operational efficiencies and financial goals.

All content / information present here is the exclusive property of Tata Consultancy Services Limited (TCS). The content / information contained here is correct at the time of publishing. No material from here may be copied, modified, reproduced, republished, uploaded, transmitted, posted or distributed in any form without prior written permission from TCS. Unauthorized use of the content / information appearing here may violate copyright, trademark and other applicable laws, and could result in criminal or civil penalties. Copyright © 2014 Tata Consultancy Services Limited

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ContactFor more information about TCS’ Business Process Services Unit, visit: www.tcs.com/bps (http://www.tcs.com/bps) Email: [email protected]

About TCS' Business Process Services Unit

Enterprises seek to drive business growth and agility through innovation in an increasingly regulated, competitive, and global market. TCS helps clients achieve these goals by managing and executing their business operations effectively and efficiently.

TCS' Business Process Services (BPS) include core industry-specific processes, analytics and insights, and enterprise services such as finance and accounting, HR, and supply chain management.

TMTCS creates value through its FORE simplification and transformation methodology, backed by its TMdeep domain expertise, extensive technology experience, and TRAPEZE governance enablers and

solutions. TCS complements its experience and expertise with innovative delivery models such as using robotic automation and providing Business Processes as a Service (BPaaS).

TCS' BPS unit has been positioned in the leaders' quadrant for various service lines by many leading analyst firms. With over four decades of global experience and a delivery footprint spanning six continents, TCS is one of the largest BPS providers today.

About Tata Consultancy Services (TCS)Tata Consultancy Services is an IT services, consulting and business solutions organization that delivers real results to global business, ensuring a level of certainty no other firm can match.TCS offers a consulting-led, integrated portfolio of IT and IT-enabled infrastructure, engineering and

TMassurance services. This is delivered through its unique Global Network Delivery Model , recognized as the benchmark of excellence in software development. A part of the Tata Group, India’s largest industrial conglomerate, TCS has a global footprint and is listed on the National Stock Exchange and Bombay Stock Exchange in India.

For more information, visit us at www.tcs.com

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