Companies that apply best practices select a small number of key financial statistics and ratios to watch closely, keeping in mind the company's circumstances and objectives. Ratios and statistics are more meaningful if evaluated in terms of their trends over time. To broaden the focus of financial analysis, high-performance companies compare their numbers to those of competitors and best-of-class performers.
The balanced scorecard approach to financial reporting is particularly powerful. For a balanced scorecard, the company selects a short list of measures that not only indicates the operational and financial health of the business, but also its level of customer satisfaction and the creative health of the business. An example of a balanced scorecard is one that chooses measures that focus on four critical issues:
- The customer perspective: how do customers see the company?
- The internal business perspective: what must the company excel at?
- The innovation and learning perspective: can the company continue to improve and create value?
- The financial perspective: how does the company look to shareholders?
Taking a balanced scorecard approach, a company creates performance measures to track all levels of the company that reflect these four critical issues. For example, on periodic internal reports, customer satisfaction metrics and statistics on the number of employees participating in coursework are reported right alongside finance and operations numbers. To create meaningful report content, employees from finance, operations, and other functional areas need to collaborate with one another.
Use cost-volume-profit analysis, contribution margins, and relevant costs and qualitative factors to evaluate business opportunities.
From time to time, a company considers special business opportunities such as special order requests and outsourcing possibilities. Specific reporting and analysis methods assist a company in deciding whether or not to take advantage of such opportunities.
Methods such as cost-volume-profit analysis, contribution margin calculation, and relevant cost calculation help a company to evaluate the impact of expected changes in the volume of sales on resulting costs and profits.
Special business opportunities require a company to look at short-term financial issues -- such as revenues, expenses, and cash flow -- as opposed to long-term financial issues such as equity distribution and indebtedness. Also, when evaluating special opportunities, in addition to looking at the numbers, companies need to consider qualitative factors. Market expectations and customer expectations should always play a role in a company's decision to accept a one-time special order or to outsource its core business. Will existing customer schedules be affected? Will the company lose expertise in a key skill area? Are there hidden costs, like training and supervising time, that do not appear in the original analysis?
Use the attributes of world-class financial information systems to evaluate and improve the company's existing financial information systems.
At the foundation of effective internal financial reporting is a robust information system that collects and disseminates information flexibly and reliably. Best practices companies study the attributes of a world-class information system and look for computer hardware, software, and systems design for their business that deliver these attributes:
- Standardized: the system captures and processes information consistently throughout the company
- Complete: the system handles the information requirements of diverse groups of users
- Appropriate: the information is relevant, predictive, exception oriented, and at the right level of detail
- Unified: the system has information links to customers and suppliers, and changes to data in one area move through the whole system
- Flexible: applications may be tailored to the company's needs
- Cost-effective: the system makes efficient use of hardware and software licenses
- Easy to use: all types of users are comfortable with the system
- Timely: the system provides information when it's needed
Ensure that key decision makers understand the strengths and weaknesses of internal financial information.
Internal information has its limitations. The information is more meaningful and relevant when decision makers understand its limits, how it is produced, and how it can help them.
The finance group can assist management in understanding internal financial information by explaining the processes that underlie it. For example, the finance group can explain how the financial system measures, records, and classifies transactions; how the finance group periodically summarizes and reports financial information; and the meaning and limitations on interpreting the information. One limitation of internal information is its bias toward analyzing the past and focusing on short-term profitability. Another is its tendency to focus on issues important only to the company, opposed to issues of concern to customers as well.
Provide accurate and reliable activity-based cost information for resource allocation decision making.
Activity-based costing (ABC) is a powerful tool that companies use to determine which activities contribute to profitability. The concept of ABC is to distill a company's production process into a set of activities and then attribute and analyze costs by activity. With ABC, a company sees which activities cause its costs.
Implementing ABC lets a company allocate resources based on critical activities; eliminate redundant activities and costs; eliminate activities that do not add value to the customer; set budget levels in accordance with activities that cause costs; and place more reliable information on activities and processes into the hands of management.
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