Over the years, I have supported many executives who found great comfort in spreadsheets. They had a bottomless appetite for KPIs, P&Ls and other acronyms that make me sound very finance-y.
These leaders were big believers in The McKinsey Maxim: “What you can measure you can manage.” Good advice, albeit lacking in the one thing it espouses: Quantification. Just because you CAN measure it, doesn’t mean you SHOULD. In decision-making, more information isn’t always better. The key is to measure the right things.
In 2005, Malcolm Gladwell published the book Blink, and briefly convinced the world that we were using too much information to make decisions. To support his claim, he shared the story of emergency room doctors at Cook County Hospital in Chicago. These doctors honed in on 3 variables to predict whether a patient coming to the ER with chest pain would have a heart attack within 72 hours. Tuning out other variables like age and weight, and simply focusing on 3 critical pieces of information – blood pressure, ECG and fluid in the patient’s lungs – the Cook County ER took their predictive success rate to 95%.
Despite the success of Gladwell’s book and the Cook County ER, we have seen a massive surge in measurement and analytics. Emphasis on big data and key performance indicators has proliferated across C-Suites and boardrooms, and yet decision-making has not become any easier. With so much information available, it has become critical for finance teams to do more than just provide numbers to the business.
Finance has to guide the business to Measure What Matters.
Here are a few tips to tune out the noise and focus on the metrics that matter to your business:
1. Measurement should align with your strategy.
- It sounds so obvious and yet you’d be surprised how many executives insist on measuring spending increases even when their strategy is to increase revenue (which may require more spending).
- If you have a clear strategy, it will typically include words like “grow,” “expand,” “increase,” “proliferate” and so on. And behind those words is a number. Always. The starting point is to put a number to your goal, and then compare your performance to it. Again, simple, obvious stuff. You’d be surprised how often companies don’t do it.
- Underneath your total company goals should be functional goals that drive the corporate strategy. Each of your functional business owners should have quantifiable goals that are connected to your corporate strategy. Ask each leader for the top three, and then measure against them.
2. Targets should be clear and measurable.
- Use benchmarks to arrive at meaningful targets: How does this year’s performance compare to last year? To your strategic plan and your budget? To the overall performance of the market? To peers operating in the same space?
- A clear target requires support – assumptions that suggest the target is achievable and promotes buy-in from those who are responsible for delivering on it.
- Ideally, the assumptions should come from the same team accountable for hitting the target – usually Products and Sales.
- The finance team and leadership should provide a check and balance to the assumptions provided by Sales and Product teams by using benchmarks to validate or challenge the target.
3. Emphasize forward-looking indicators over historical performance.
- Reports that only focus on “what has happened” provide limited visibility to your path forward, and are somewhat useless in driving actions to correct any missteps.
- While it is important to understand past performance, decision-making is best supported by projections that align with your assumptions going forward.
- Assumptions should be clear and quantifiable so that you can measure their accuracy across time.
4. Report metrics timely while they are still actionable.
- It is important to provide the business with information while they can still take action.
- Better yet, providing the business with options for actions, and quantifying the results of those options is the best way to go.
5. Limit metrics per function or business group to three.
- Yes, only three.
- As in one more than two.
- Yup, just 3.
Some Pitfalls to Avoid
In addition to suffering information overload, many companies spend too much time measuring the wrong thing. Here are a few pitfalls you should avoid:
1. Reactive approaches to reporting.
- Try to give the business what they NEED, not just what they think they want.
- You have a new COO, and she is all about the numbers. She thinks it’s a good idea to produce a 200 page operations review each month. To adequately deliver, you need to spend 3 out of every 4 weeks assembling reports and presentations, leaving the other 1 to actually deliver on what the report is intended to measure.
- Partner with the COO to gain a better understanding of the questions she is trying to answer.
- Recommend a more concise, focused approach.
2. Charge-backs and other fake numbers.
- First, let’s distinguish a charge-back from an allocation. An allocation is when you take a shared cost for an item or service – like rent for your offices – and charge it to all the various groups that use the item or service; A charge-back is an expense that is moved back and forth across the P&L like a bad cold.
- The person who actually spent the money believes that it should be charged to the group that made them perform their service; and the person who required the service believes it should be charged to the person who spent the money. The result – it goes into a no-man’s-land “charge-back” account, where it is ignored by all parties. They treat it like a passing UFO. (Did you see anything? Yeah, me neither.)
- Allocations are necessary; charge-backs are a passive-aggressive nuisance.
- Regardless, the act of making charges from one function to another is like squeezing on a balloon. The air has to go somewhere, and it tends to go to the P&L that isn’t part of the presentation you are preparing. You are just making one P&L look better at the expense of making another one look worse. You aren’t getting rid of those costs, you are just passing the buck.
- Hard fast rule: the person who spent the money, made decisions about the vendor or hired the person, and controls whether that money gets spent or not, should own the cost. The only good reason to charge centrally managed costs out to another P&L is if you get some sort of tax benefit.
3. “Real-time” financials.
- There is always at least one executive who worked at some mythical company that reported their financials “in real time.” Pay no mind to the fact that employees are only paid twice monthly, that revenues for your company follow complex revenue recognition rules that require review before they are posted, or that a good 60-70% of your costs are booked at month-end as accruals, it is critical that you provide a “real-time” view of your P&L.
- There is no such thing as “real-time” financial statements – at least not accurate ones. You may be able to report your sales in real-time, and you may be able to get limited visibility into spending, but a full P&L should only be reported when it is truly “full.” Exposing your P&L in the middle of a period, when important things like revenue and compensation have yet to be booked in their entirety will only confuse everyone and create a reconciliation issue when the real numbers are reported.
4. Agenda-based reporting.
- Metrics are typically presented to support a thesis, and financial projections are subjective.
- Beware the executive who tries to manipulate the numbers to tell a story that the numbers themselves defy.
- This is the tightrope that we walk in finance. Support for your business partners requires that you do two things: provide the analysis requested, but also provide support for the best decision. They are not always the same.
- If there is subjectivity to the analysis, be sure to make the subjective assumptions salient, and provide relevant comparisons to validate them.
5. False precision.
- Projections are educated guesses, supported by assumptions that can be quantified. While your numbers should align with your assumptions, they should not be overly precise.
- Instead, use round numbers. Suggesting that you can predict 5 years of quarterly revenue down to the dollar gives your audience the sense that the model is over-engineered.
- Be mindful of the thesis you are supporting. There is no need to make nickel-and-dime changes to projections if it doesn’t change the thesis you are presenting.
With big data and analytics becoming increasing popular, businesses are inundated with too much information, and frequently measure the wrong thing. CFO’s and financial leaders need to partner with the business to focus on the right metrics and drive good decisions.