Hidden Profits Blog

In the competitive economic environment on the 21st century, finance is expected to be strategic and focus on providing accurate and very timely information for operation decision making and optimizing profits and shareholder value.  In addition the finance team in today’s businesses is responsible for developing appropriate controls and reducing risk to the operation. That puts big demands of the CFO and finance function.

In my last post I discussed the Financial Supply Chain and the importance of its optimization on working capital and sustained profitability.  This week I found an article from 2006 which again reinforces the importance of an optimized Financial Supply Chain in enabling the Finance Function to be more strategic.  The title of the article is ‘Best Practices in Creating a Strategic Finance Function’ by Katharina Muellers-Patel.

http://whitepapers.zdnet.com/abstract.aspx?docid=28204

In 2006, the author showed the breakdown of Finance function and the time devoted to them as follows:

Transaction Processing – 44%

Controls   –  21%

Management – 18%

Decision Support – 17%

So 65% of the finance function in companies is consumed by transaction processing and the controls of the transaction processing function.  Most of that time can be eliminated through efficient use of information technology and organizational and process efficiency.  The article sites that at that time top performing companies allocate only 30% to transaction processing and 45% to decision support and management activities. While that is a significant improvement I believe it can be better. The article sited that the main source of differences between the top performing vs. lower performing companies are the organizational structure for finance and the type of Information Technology (IT). 

The organizational structure generally focused on shared services finance organizations and outsourcing.  The primary benefit from outsourcing is the use of lower cost labor.  In my experience the problems associated with outsourcing of financial transaction processing is that the information transfer between the company systems and the outsource company’s system makes the organization cumbersome.  Also, since the primary  benefit is lower cost labor, eventually the cost of that labor will begin to increase thus lessening the benefit.  Also, there is no additional benefit to profitability.

In general companies tend to opt for a shared services organization.  The key to the success of this structure is not just creating the organization, but also creating optimized process and efficient utilization of technology.  For example, creating a shared services organization in which each of the combined organizations utilize different financial systems or different instances of the same system does not provide any benefit to the company.  Instead it places greater strain on the employees in the shared services organization as they must learn the different systems and continuously log on and off of systems in order to process all the transactions.  I have seen this situation at multiple clients and they are always a mess.  The article sites 3 different examples of companies that created shared services organizations especially one that continued to obtain improvement by changing technology platforms.  The shared service function was AP.  The initial structure the shared group used the multiple systems from each of the original companies.  Then they made significant improvement by just moving to a single ERP  platform and at the time of the writing they were changing the platform again to create a completely automated and integrated procure to pay function.

The study in the article showed that in general companies that had automated more than 66% of their finance processes had average finance costs of 1.2%  of revenues while companies with less automation had average finance costs of 3.0% of revenue.  Companies that relied on manual process and spreadsheets had process costs of $2.21 per $1000 of revenue while those with efficient automated processes had costs of $0.72 per $1000 of revenue.  The study also showed a correlation between the significance of the cost reduction and the simplicity of the information technology systems.  IT simplicity refers to standardized applications, integration of systems, and use of ubiquitous user interfaces such as web and smart phones and integration with partners (banks, vendors, and customers).

Today automation is much more that simply implementing ERP systems.  For an assessment of your companies finance processes and technology call LJR Consulting Services at 818-709-6583.

I am reading a new book ‘Optimizing Back Office Operations: Best Practices to Maximize Profitability’ by Zahid Khalid.  While the title may sound a little boring, I was so excited to find this book. It is a very good read and definitely not boring!  Zahid has gone into detail of the business case for creating lean business processes in back office operations.  He has given the name ‘Financial Supply Chain’ to all the operations that are performed to consummate the business transactions for a company and document them per accounting and regulatory requirements.  This is a perfect description of these processes because

1. It is a simple and easily understood metaphor for all the business processes

2. It describes the importance of these business processes.

www.amazon.com/Optimizing-Back-Office-Operations-Profitability/dp/0470531894

Most business people understand the importance of the Operations Supply Chain and impact on the businesses profitability.  If your operations supply chain is inefficient, manual, and ineffective, most businesses would be out of business in today’s competitive environment.  As Zahid points out many companies like Dell have grown dramatically and become leaders in their industry because of the advances and often complete redesign of their Operations Supply Chain.  As with Dell, the Operations Supply Chain has given them a competitive advantage.

Zahid asks the question ‘What is the compelling reason for taking the plunge into the world of financial supply chain?’  Answer ‘ CASH’!  He states that independent studies conducted by several research firms estimated that between $500 billion and $1 trillion is tied up in unnecessary working capital globally in the financial supply chain.  That is a lot of money and a lot of lost profitability!!!!   As Zahid points out  ‘Working capital optimization improves cash flow, thereby minimizing reliance on lines of credit and other short-term borrowing.’ It also reduces time required to perform the tasks of the financial supply chain, reduces the number of employees required, improves the accuracy of the information produced and provides that information in a timelier manner for decision making.

Let’s discuss each of these benefits in a little detail

1.  Minimize reliance on lines of credit and borrowing.  In the easy money days of a couple of years ago most executives did not worry about how much they used credit and just accepted it as a need in business.  Now, however, with banks pulling back on credit, executives are seeing their ability to meet the demands of their businesses severely restricted.  Reducing dependence on credit now means survival to many businesses.

2.  Reducing time required to perform the tasks of the supply chain.  This has numerous benefits since when we reduce time we reduce cost of each transaction which goes directly to profit.  As we all know $1 of reduced cost translates directly to $1 of increased profit.  However, usually reduced cost means pain but by creating a lean optimized process, you can have reduced cost without pain.

3.  Reducing the number of employees is part of the reduction in cost.  It also helps to improve accuracy because we all know that the less hands in the soup the better it is. 

4.  Improving the accuracy of the information produced is one of the most critical aspects of Financial Supply Chain optimization.  It is the equivalent of reducing errors and waste in the Operations Supply chain.  Poor quality of information leads to embarrassing restatement of financial results, poor management decisions, loss of revenue, and increased cost from late charges, and inaccurate payments.

5. More timely information for  decision making is probably the most significant benefit.  In the days when business moved at a slower pace it was ok to use information that was aged for decision making.  But information is not like a fine wine that gets better with age, it rots. Today information has a very short shelf life and to manage a successful business information is needed when it is happening not 30 days after the fact.

As we have discussed on some of these posts creating lean or optimized business process requires a combination of process change enabled by information technology and services from financial supply chain partners such as banks.  It also requires team members that have knowledge of finance, change management, and information technology.  Optimizing your Financial Supply Chain may be challenging and time-consuming but also extremely profitable.  Contact us at 818-227-5025 to discuss how an Optimized Financial Supply Chain can improve your profitability.