The biggest challenges facing Spanish companies are growth and increasing margins, according to the main conclusions of the market study commissioned by American Express and conducted by Brain Trust CS in May 2016 and published by Asset.
Challenges and Trends for 2016 Companies Capital Optimization
Who wouldn't want to take on these challenges?
The traditional functions of finance —setting dividend policy, maintaining an appropriate financial structure, seeking financing, establishing commercial risk policies, managing cash flow, setting up collection and payment methods, and preparing financial statements— are no longer sufficient.
The next task is to quantify these challenges and draw up a plan to achieve them. The CFO should be responsible for giving overall meaning to the organization's objectives. This work must be done in collaboration with the different departments of the company. It is necessary to leave the office and get to know the different realities firsthand. This will make it much easier to establish, prioritize, coordinate, and monitor indicators that help the company achieve its goals.
If we asked the people in our organization: What are the company's three strategic priorities? Do you think everyone would give the same answer? And if all the teams are not pushing in the same direction, how can we all be aligned? More indicators do not mean better performance and greater control. If the indicators are not ranked, they are useless. Instead of aligning people, they scatter them.
There are many times when improvements come exclusively from better coordination between different departments. It is not the first time I have seen companies where the relationship between the manufacturing and sales departments is not smooth. It is in these cases that financial management must intervene. I have been present when factory management boasted that, without information from the sales department and with the strong growth in the market, they had only run out of stock for two days in a year. It is not a question of departments patting themselves on the back. It is essential to progress as a team. My questions were: how much could you have saved if you had been aware of this? How many hours of overtime? How much less inventory? How much could you have increased productivity by planning better? How much more could you have sold?
Are my KPIs good?
Nothing helps us improve more than knowing how we will be measured. At a dairy company where I was in charge of finance and purchasing at headquarters, we were asked to improve margins. Contrary to the preferences of most companies in the dairy sector, the factory manager asked for milk with a higher protein content. He was convinced that the more protein there was, the fewer liters of milk would be needed to make the final product. He committed to improving production yields (reducing the liters of milk per kilo of finished product) if the milk collected had a higher protein content.
We conducted a test. We would pay farmers on certain routes more for protein than the rest of the market, while maintaining the same payment level for fat. Within three weeks, milk routes began to arrive with more protein. Factory yields improved considerably more than the extra cost of protein. Not only did factory yields improve, but so did the average price of milk. The overall result was a 0.2% increase in gross margin. In conversations we had with farmers, they confirmed that it was also profitable for them to change their cows' feed in exchange for higher protein payments.
Create indicators that improve results
This example should serve to illustrate the difference between a KPI (Key Performance Indicator) and an RPI (Result Performance Indicator).
- KPI (Key Performance Indicator): It involves measuring a specific task that we are doing, which will subsequently have an impact on the income statement. In this example, there are several KPIs that we are working on:
- Level of protein in milk entering the factory.
- The average cost of a liter of milk.
- Yield (liters of milk per kilogram of product).
- RPI (Result Performance Indicator): these are the financial summary of a series of tasks. In the example given above, it refers to the measurement of gross margin and its improvement by 0.2%.
It is easier to know whether gross margin is improving or not by measuring the evolution of the three factors than by setting a generic target of a 0.2% improvement in gross margin within the organization.
What we mistakenly call KPIs, such as % sales growth, gross margin, commercial margin, ROI, and EBITDA, are actually RPIs. In other words, they serve to measure the degree to which the company's objectives have been achieved, but not to explain why.
Let's look at a comparison table to see how we can differentiate between them:
Characteristics of RPIs |
Characteristics of KPIs |
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To determine whether we are dealing with a true KPI, the key is to ask ourselves: why did this happen? If there is an answer, then we are not dealing with a KPI. Following the previous example, we can ask ourselves: Why have we improved the margin by 0.2% (RPI)? Because we have changed our milk purchasing policy, favoring the arrival of milk with higher protein content (KPI), which, although it increases the cost per liter of milk (KPI), increases the productivity of liters/kg (KPI). The factory's productivity is not only increased by the change in milk purchasing policies, but there may also be other factors. The key is to know how to measure how much each measure is contributing to the improvement in productivity and the improvement in the overall margin.
Global Indicators
It is as important for the company to set its strategic priorities as it is to communicate them within the organization and assign aligned responsibilities. Three strategic priorities for one year is already a good challenge to align the organization.
How many companies have contradictory indicators depending on the department in question? Purchasing is putting pressure on suppliers who provide materials below the required quality standards, causing problems in manufacturing (returns, non-conformities, non-quality costs). Or purchasing obtains lower prices by buying larger volumes, which then penalizes inventories. Or logistics improves its costs but significantly worsens customer service. Or sales departments increase their sales or give "commercial gifts" to reach their targets, even though they are aware that this may lead to customer returns that were agreed upon under the table.
Financial information (improved margins, growth) must be translated into global challenges with which we can identify as a company. Examples include the number of active customers or products sold (who can't relate to the challenge of how many cars a factory sells, or how many kilograms are produced or processed?). From there, it's easy to come up with a big number to show how much we're billing and earning, and what levels determine whether we're having a good or bad year. It is of no use to us if the sales department does a good job if we are then losing customers due to the poor quality of the product/service offered. Hence the insistence on having global measures with which to measure the performance of the organization. Bonuses for company objectives always work better than those for departments because they encourage cooperation.
The finance department is the only one capable of preparing the company's entire reporting system in a coherent manner and with a global vision. Starting from a global vision, a series of indicators will be deployed by department to help improve management. The information prepared for this purpose should also allow us to manage, for example:
- Customers/Products: How much is earned per product or customer? Based on this information, what decisions should be made regarding pricing, range, product definition/product improvements, and commercial incentives?
- Operations: Which activities save us the most money? Are there any bottlenecks? Are indirect costs directly related to units sold? What are the priority areas for improvement?
We must avoid management committee meetings where each department prepares its information in the way that best suits it. These reports are usually biased (relevant information is missing) and then do not add up or have no effect on the income statement because not all the data has been taken into account. We are all aware of the often condoned "tricks" that are commonly used to ensure that departments and their staff receive their variable pay. But deceiving ourselves about the performance level of the company as a whole is a serious matter that leads to complacency and a lack of improvement.
And to find out if we are really helping the company as a whole, just ask yourself this question: Does the entire company already know what its THREE STRATEGIC PRIORITIES are for this year? How will they be measured? What does each department have to contribute to achieve them?
Below is a work outline of how to organize and structure all company information both by cost centers (activities) and by products.
Indicators for everyday use
How do we know if today has been a good or bad day at work? Do we have to wait until the end of the month to see the results? How great would it be if, based on the company's goals, we all knew at the end of the day whether or not we had contributed and by how much. And how important it is for us all to know whether we are on track, above or below what is expected of us.
We are going to include a table here attempting to display day-to-day indicators that do have an impact on the income statement depending on the departments, suggesting possible actions that could help improve results.
In the sales department, the most important thing is sales figures and margins. But for this to happen, we need to understand the reasons behind them:
Indicator |
Measure |
Comments |
Possible actions |
| Average margin per customer |
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| Active customers |
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| Target percentage |
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For the manufacturing department, improving profitability is key. Here are some examples:
Indicator |
Measure |
Comments |
Possible actions |
| Productivity |
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| % resource utilization |
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| Performance |
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For the purchasing department, prices are important:
Indicator |
Measure |
Comments |
Possible actions |
| Price deviation |
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It is the responsibility of each department, together with the finance department (which will prepare periodic reports), to identify which activities directly influence the achievement of each indicator and how they can be monitored.
Following up
If you want something to be done and your teams to be committed, there is nothing better than putting your objectives in writing. This applies not only to business life, but also to personal life. People's level of commitment increases when things are put in writing. At a meeting of a company's management committee, a sales representative complained that he was not selling more because he needed to expand and advertise some warranty clauses that were going to be unique in the market. When senior management agreed to his request in exchange for a written commitment to increase sales, those clauses were no longer so decisive and he could not commit to a number.
Likewise, if there is an annual financial objective (broken down into operational indicators), it is much more motivating to monitor it periodically than to reach the end of the year without knowing how we have progressed and to what extent we have achieved our goals.
The best way to analyze deviations is by their causes:
- Price deviations. This involves quantifying the impact of a price variation on the income statement:
- How do promotions affect sales? Or to put it another way, how much more do you have to sell to make the promotion worthwhile?
- What impact does a change in the purchase price of raw materials have on our overall income statement, by product and customer? Is it worth insuring the operation?
- Quantity deviations. Here we talk about yields and ratios.
- What is the conversion rate of our sales visits? What actions can we take to improve the rate? Are there any best practices that we can transfer to other departments?
- How much energy/machine hours/man hours do we consume per unit produced? Is preventive maintenance necessary? Do we need to review our working methods?
- Deviations due to mix. Changes due to selling one product or service more than another. How is this affecting our margins? What actions can be taken to maintain the mix or redirect it?
Below is an example of how performance deviations can be broken down from a global view (from most to least important) to a specific product.
The key to good follow-up is knowing the causes and taking action.
In conclusion: financial management must take on new challenges...
