Where does finance sit within performance management?

augustus 2018

Where does finance sit within performance management?

Many organisations have elaborate measurement systems that allow them to keep track of the slightest movements in performance of the their business. They register masses of data and have several sophisticated analysis tools that allow them to look at performance from every angle.

Key Performance Indicators

Managers often spend quite some time in collecting data or if not in having their team members collecting data. In management meetings, a big proportion of the time goes to looking at KPI’s (Key Performance Indicators) and it is no exception to find that different managers come up with different results when those KPI’s are analysed.

Not only does this require an enormous amount of time and effort, it leads to sometimes heated but mostly futile debates about which number is the right one. Furthermore, the wide range of KPI’s tends to be looked at from a functional or departmental basis and most of the time this leads to suboptimisation, double counting of benefits.

It is quite common to have departments that are measured and even rewarded on a set of KPI’s that show excellent results in one corner of the organisation, whilst their success is at the expense of other parts of the business. Who has not heard of a procurement department that has generated impressive savings by finding alternative sources of materials and by squeezing every last drop out of their suppliers whilst production departments struggle with quality or service issues as a consequence.

Balanced Score Card

Every professional manager should consider the bigger picture, yet organisations continue measure and reward performance in isolation because they do not see how they can keep an integrated overview of all these components of their business.

Some relief is offered by working with a Balanced Scorecard, yet there again there is a tendancy to see this tool as a list of separate KPI’s in which mutual influence is ignored for the sake of simplicity. Several indicators are brought together in a flashy dash board and at best trends are shown and deviation from targets is visualised. An example of such a scorecard is given below:




If the scorecard is to be truly balanced, it should cover several  aspects of the business starting with the People KPI’s (often overlooked), the Process KPI’s (often in overwhelming quantity), the Customer KPI’s (often confused with internal measurements of performance) and finally the Financial KPI’s (often the prerogative of the finance department).

The fact that all these KPI’s figure on the same page does not make the scorecard balanced.

The true value comes from the right interpretation in the right sequence. We tend to forget that it is the people that make the processes work, that these processes lead to customer satisfaction and that only then can we achieve the right financial results. 

How often do we not notice however that organisations tend to look at their financial results and focus their efforts for action on the financial KPI’s  as if pulling the grass will make it grow faster. The secret of well growing grass, as we all know is good lots of water and sun and a good fertiliser. All managers should be trained in understanding the right sequence of performance management. That is why a program on financial management should spend quite some time on understanding the drivers of good financial results.

Connect KPIs and financial results

Another phenomenon in companies, is the lack of connection between the operational, departmental KPI’s and the financial results. Well versed operational managers will know all about waste, overall equipment efficiency, tact time, throughput, productivity, labour efficiency, delivery service, stock levels, change over times, SMED, ... Commercial people will know all about market share, price movements, rebates, sales growth, gains and losses of business and departmental heads will know all about cost budgets, head count, overhead costs, ...

When the question is raised however how all of these contribute to the final financial result and how we know whether they are taking the right decisions in negotiations or investments, we often notice that many managers work on a gut feeling, but do not really know if their decisions have the right impact on the overall results.

Say a purchasing manager needs to decide whether he can negotiate lower prices in exchange for longer delivery lead times (say delivery from the Far East instead of the next door supplier). How will he know whether he has taken the right decision?

Say a general manager decides to cut the training budget for new recruits and as a result it takes new people a month longer to autonomously operate a sophisticated piece of machinery. Is it the right decision?

Say a sales manager needs to decide whether he will launch a promotion that will generate double the volume of sales in one month, yet it will require an additional discount to be given to the customer and production will need to build more stock to be able to deal with the extra volume. What makes it a good decision?

Suppose investing in new equipment will increase capacity by 50%. Having this sprint capacity allows for reducing the required stocks and allows for even increasing sales volume. The unit cost of the products is even going to be lower, so margins are likely to improve. However, the sales manager says that in order to increase the sales volume, he will need to give price concessions. Is the investment a good decision?

Such questions can only be answered properly if we take all variables into account and bring them together in one model that looks at the financial outcome from the perspective of the shareholder. Shareholders are predominantly interested in return on their invested capital. In order to know the answer to the questions above, we therefore need to determine what additional capital the decision requires and what additional benefits it brings.

Master the statements

All of this information we can find in the financial statements.

Balance Sheets tell us about capital employed, Income Statements tell us about the benefits of our decisions and the Cash Flow keeps track of the final outcome.

Mastering these statements and the impact of our decisions on them is essential for managers to know if their decisions make sense.

It is therefore necessary that KPI’s, Balanced Scorecards and Financial Statements find each other. Their meeting point is the all encompassing financial KPI = ROCE (Return on Capital Employed). This is what interests us when we put our money in the bank, it is what interests shareholders when they invest in a company and is should be the focal point of all managers when they make their decisions.

All of this information we can find in the financial statements.

Balance Sheets tell us about capital employed, Income Statements tell us about the benefits of our decisions and the Cash Flow keeps track of the final outcome.

Mastering these statements and the impact of our decisions on them is essential for managers to know if their decisions make sense.

It is therefore necessary that KPI’s, Balanced Scorecards and Financial Statements find each other. Their meeting point is the all encompassing financial KPI = ROCE (Return on Capital Employed). This is what interests us when we put our money in the bank, it is what interests shareholders when they invest in a company and is should be the focal point of all managers when they make their decisions.

You can find out all about Balanced Scorecard, Financial Statements, Cost and Benefit Drivers, impacting variables on ROCE and how all of these connect to each other in the Finance Management Expert Program by Amelior.