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41SEPTEMBER/OCTOBER 2015 COST MANAGEMENT

In today’s business climate of globalvolat i l it y, increased regulator ymandates, changing consumerbehavior, and disruptive technol-ogy, the role of the CFO has evolved

far beyond the traditional disciplines offinance. Stakeholders expect maximumefficiency in operational finance func-tions, and regulators and statutory bodiesalike expect effective controls and riskmanagement discipline in organizations’audit , regulator y, and statutor y f i l ingprocesses. These processes, coupled witheffective talent management, are the coredrivers guiding the chief financial officer(CFO) in managing the pillars of finance,risk, and capital.

Today, organizat ions l ive and die bythe decisions they make, so convert ingthe explosion of enterprise data to action-able information is paramount. As the onefunction that touches al l other aspectsof the enterprise, once the financial closeprocess has been optimized, finance hasan opportunity to provide tremendousvalue to internal business par tners byfaci l itat ing and support ing the closedloop management disciplines of strate-gic planning, rolling forecasts, and prof-itability analysis. By making continuousplanning and analy t ics part of the cul-ture of an organization and maintaininga forward-looking view, finance can pos-

it ively inf luence enterpr ise value in astrategic manner — putting the “A” backinto FP&A (financial planning and analy-sis). This article will describe some of thetrends found w ithin high-per formingfinancial organizat ions and discuss therole of the esoteric cost al locat ion as acrit ical data enrichment mechanism inthose processes.

Business backgroundOrganizat ions today face a highly com-petit ive global marketplace. Their abil-i t y to cont ro l cos t s and generatesustainable, profitable growth is imper-ative to creating shareholder value. Whilemany costs are directly attributable to pro-ducing the goods and ser v ices of theorganization, additional indirect costs willbe found throughout the organizat ionat vary ing levels that are typical ly ser-v ice-orientated in nature.

Organizations are constantly lookingfor ways to manage indirect costs as ameans of achieving greater profitability.One mechanism is through the reorga-nization of resources into shared servicescenters and establ ishing standardizedprocesses supported by information tech-nology to optimize them. This typicallyhas the effect of creating a new servicescompany, and the various functions of

PUT THE “A” BACK

INTO FP&AMIKE K I LLEEN

M I K E K I L L E E N is the senior v ice president of technology and strategy for Edgewater Ranzal (w w w. r a n z a l . c o m ), an Ora-cle Platinum consulting partner. With more than 18 years of implementation experience, he has expertise in architecting mul-tiproduct solutions to complex business problems, helping organizations maximize their investments in business analyticsapplications and technology. He can be reached at m k i l l e e n @ r a n z a l . c o m .

This ar ticle outlines how to establish a high-per forming organization

with prof itability evangelism from today’s f inance function.

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the organization (such as IT, facilit ies,and finance) that transition to it are nowinternal service providers to the rest ofthe organization. As part of this process,a new service chargeback mechanism isestablished, which al lows internal ser-vice receivers to have greater visibilityinto chargebacks, and functional serviceowners to manage cost and service deliv-ery on a cost-neutral basis.

While the office of the CFO is concernedwith the effective utilization of resourcesand the fairness of the chargeback processfrom a management standpoint, in manyregulated industr ies, there must also befull transparency into the costing mech-anisms and reconciliation between inter-na l management and any ex te rna lstatutory or regulatory mandated results.For example, health-care payers mustabide by rules around medical loss ratiosand what port ion of premiums may beconsumed by administrat ion expenses.Allowing an organization to understandand manage these costs from a manage-ment standpoint while “pivoting” to analternative reporting v iew and ensuringtransparency in the process is cr it icalto any cost ing solut ion.

Regulated or not , near ly a l l g loba lorganizat ions that provide value-addedinternal serv ices have transfer pricingconsiderations when those services crossjurisdict ions. These fees show on mosts t atutor y prof i t and lo s s s t atement s(P&Ls) as “management fees” and arebased on similar shared serv ices al lo-cat ion methodologies w ith addit ionalmarkup and stewardship factors.

Out s ide o f co s t cont a inment andensur ing compl i ance and cont ro l inbr idging the gap between manager ia l ,s t atutor y, and regu lator y repor t ing ,CFOs and ch i e f exe cut ive o f f i c e r s(CEOs) are looking to unlock the poten-t ia l of their businesses to dr ive prof-itable grow th. The main role of FP&Ain this regard is to provide the informationand analytics for senior leadership to makedecisions about:• eliminating or invest ing more inunderperforming products;

• putt ing more focus on underservedcustomer segments;

• improving ut i l izat ion of exist ingstaff and capacity ;

• putt ing the excess cash on the bal-ance sheet to work — invest ing in

42 COST MANAGEMENT SEPTEMBER/OCTOBER 2015 FINANCIAL ANALYSIS

EXHIBIT 1 FAST Characteristics

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

new markets, products, and ser-v ices; and

• creat ing more efficient businessprocesses and reducing IT complex-ity to reduce costs.To achieve the aforementioned, com-

panies require information to not onlyimprove the quality, t imeliness, and effi-ciency of the activities they perform, butalso to fully understand the accurate costsand profitability of their individual prod-ucts, services, and customers. Managementgurus and research firms alike have his-torically evidenced this mandate.

According to the 2010 Gartner Financial Exec-utives International (FEI) technology study,the most significant constraint with the officeof finance is the ability to understand profitability,including at the product and customer levels.This was cr it ical during the economic down-turn, but may be more important as compa-nies return to growth.1

For example, financial serv ices inst i-tut ions need to calculate profitabi l it yinformation by product, channel, seg-ment, and even individual customer. Veryoften, they wil l v iew their businesses asportfolios of customers, and like most port-fol io managers, they need to separatethe winners from the losers. Specifically,what is it about their best customers —their features and attributes — that makethem winners, and what is it about their

weaker customers that make them unprof-itable? A typical client profitability dis-tribution would reveal that, much like inan investment portfolio, the top 25 per-cent contribute the majority of economicprofit, the middle 50 percent can be cul-t ivated and grown, and the bottom 25percent, where possible, are fixed.

The organizat iona l des ign, cost ingapproach, and chargeback mechanisms willimpact organizational, business unit, andeven legal entity profitability. As a result,there is a compelling need for an infor-mation system that allows for the opti-mization and enablement of an evolvingshared services center (for example, estab-lishing additional regional hubs to com-plement a g lobal hub). Organizat ionshave needs for information managementsolut ions to suppor t these init iat ives.These solutions must deliver a number ofkey character ist ics, namely f lexibi l ity,accuracy, shared methodology, and trans-parency, which can be abbrev iated asFAST and are shown in Exhibit 1.

Trends with FP&AOver the last several years, our firm hasnoticed a number of consistent trendswithin the finance organizat ions of ourclients. One key trend has been a tran-

43FINANCIAL ANALYSIS SEPTEMBER/OCTOBER 2015 COST MANAGEMENT

EXHIBIT 2 Bi-Directional Link of Demand to Supply via Costing Engine

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sit ion from a financial planning processexecuted by FP&A to an integrated enter-pr ise planning process fac i l i t ated byFP&A. Examples of this include:• linking strategic plans, created in atop-down capacity, to financial plans;

• l inking operat ional plans, created ina bottoms-up capacity, to financialplans;

• improving accuracy and t imelinessby transit ioning from the once-per-year annual budget, to a rol ling, dri-ver-based monthly forecast;

• improving accountability by al low-ing direct entry of budgets, fore-casts, and plans by responsibilitycenter owners, and ensuring thatplanning and analy t ics are part ofthe everyday business culture; and

• providing for enhanced varianceanalysis by aligning actual opera-t ional drivers to planning and fore-cast ing structures.With the productiv ity gains achieved

through process and technology, the roleof FP&A is transit ioning into that of ast rateg ic business par tner — w ith anemphasis on the “A” for analysis. Exam-ples include:• faci litat ing, managing, and review-ing the planning process versus datacleansing, col lect ion, and submis-sion; and

• analyzing and enhancing internalbusiness partners’ operat ional mod-els and the impact of key opera-t ional drivers on profitability.Las t ly, there have been changes in

organizational structure for internal ser-vice providers. We have seen a greater estab-l ishment of corporate shared serv icesthat must pay for the costs they incur, andthere is a considerable focus on legalent it y s t ruc tures to suppor t e f f ic ientdelivery of services across internationaljurisdict ions.

Most of the themes associated w iththe aforementioned are focused on mak-ing CFOs better business partners andon establishing mechanisms for FP&Ato link operational drivers and activitiesto financial results. Simply put, it is theabi l it y to l ink supply-side cost struc-tures w i th i t s demand-s ide needs toanswer the following types of questions:• How big should my support func-t ions be as a percentage of revenue?

• How many sales reps should I hire ifI want to grow 10 percent this year?

• What is the impact of combiningsupport organizat ions in Region Aand discontinuing business inCountry B?

• What mix of serv ices and productsis optimal for my exist ing customerbase?

44 COST MANAGEMENT SEPTEMBER/OCTOBER 2015 FINANCIAL ANALYSIS

EXHIBIT 3 Enterprise Costing Model

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• What investments should we makein acquir ing new customers, andwhat types of customers should wetarget? There are two key management pro-

cesses utilized to support the decision-making associated with the aforemen-tioned. One is driver-based budgeting,planning, and forecasting — using oper-ational drivers to forward calculate pro-jected financial impacts and supply-sideresource needs. The other is cost man-agement and profitability analysis opera-tions — taking financial outcomes alongsupply-side structures and using operationaldrivers to pivot back to a demand-sideview. Exhibit 2 demonstrates the role of acost ing eng ine in l inking supply-s ideresource budgets — typically calculated usingresource drivers by cost center and account— to demand-side consumption needs —typica l ly measured by ac t iv it y-baseddemand drivers by customer and productor service. Think of profitability analysisas driver-based forecasting in reverse.

Edgewater Ranzal has developed a pro-prietar y v iew known as the enterprisecosting model. This model, schematically

depicted in Exhibit 3, is intended to reflectthe different types of cost ing applica-tions — ranging from financial close sup-port to management reporting and analysisand operational analy tics. In each appli-cation, while not necessarily consider-ing each a traditional costing exercise,there is the consistent theme of estab-lishing data enrichment mechanisms viaallocations, adjustments, and attributionsto generate that view. The intent behindthis model is to highlight a “start any-where” approach and the delivery of incre-menta l va lue to a par t icular businessfunct ion v ia a par t icular appl icat ion,while at the same time linking these appli-cations to each other as part of a largerfinancial systems footprint.

The enterprise costing modelIn Exhibit 3, the applicat ion types fol-low the flow of costs within the organi-zat ion from top to bottom, representedby internal serv ices provided to otherorganizat ional areas, and ult imately tothe serv ices and products delivered andthe customers who consume them. In

45FINANCIAL ANALYSIS SEPTEMBER/OCTOBER 2015 COST MANAGEMENT

EXHIBIT 4 Details of Service Charge

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our experience, shared services and inter-unit charges — whether they be via con-t r ac tua l a r r angement s ( l i ke in aninsurance company or ut i l ity) or trans-fer pricing agreements arising from hav-ing va lue-added s e r v ice s t r averseinternat ional jur isdic t ions — tend tobecome components of the financial closeprocess.

Expense al locat ions, typical ly thosethat are cost center to cost center, andfu l ly a l lo cated P&Ls tend to be thedomain of FP&A or controllership, andproduct and customer profitability veryoften w il l take the form of a businessintelligence (BI) project with input fromFP&A, operat ional analysts, and l ine-of-business (LOB) managers alike. How-ever, regardless of the application natureor ownership, they a l l share an inter-connected relat ionship throughout theorganizat ion thanks to one cr it ical andfundamental concept: How do I link sup-ply to demand across system boundariesin a flexible, efficient, and transparentway with the intent of making serv iceprov iders more cost ef fect ive in whatthey do and helping serv ice receivers tobetter understand the impact of thosedecisions on their P&Ls? This processhas to be done in a way so that ultimately,and in aggregate, the aggregations of thevarious sect ions al l t ie back to the over-al l f inancial results.

46 COST MANAGEMENT SEPTEMBER/OCTOBER 2015 FINANCIAL ANALYSIS

EXHIBIT 5 Fully Allocated P&L Methodology – By Geography,Function, and LOB

To achieve this, costing at its core willtake on the form of al locat ions as a dataenrichment mechanism — the consis-tent theme across all of these applicationtypes . The funct ional architec ture ofthese systems, which is enabled by enter-prise performance management (EPM)applicat ions built on BI technology canbe described as fol lows.1. Source and enrich hierarchies and

financial results : Very often thehierarchies ut i l ized for al locat ionprocesses are alternat ive v iews oftradit ional management or statu-tory v iews in order to simplify themaintenance of rules and faci litateeasier validat ions. For example, atradit ional cost center hierarchymight be organized around account-ability report ing, whereas an alter-nat ive v iew might be organizedaround common cost pools andallocat ion methods to simplifymaintenance.

2. Source operational dr ivers, cost poolfactors, and markups : Operat ionaldrivers may either be resource dri-vers (internal supply) or act iv itydrivers (external demand).

3. Map financial results into cost poolsusing hierarchies and rules: Thisincludes making the necessary pre-al locat ion pool adjustments inorder to create the necessary star t-ing point for any al locat ion.

4. Execute calculations and allocations:• Attr ibute supply-side pools todemand-side needs (e.g., directassignment). Attr ibutions can bedirect-spend found in a moredetai led system (e.g., vendor pay-ments on a client behalf ) or manualinputs.

• Perform al locat ions using meaning-ful cost drivers.

• Calculate rate x volume bil ledcharges (with markups as neces-sary).

• Apply cost of capital charges whereappropriate for economic profit.

5. Reporting and analysis:• Perform pre- and post-model vali-dat ions.

• Publish results and generate inter-nal invoices as necessary.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

• Analyze and explain variances andresults to stakeholders.

High performance organizationsOver the last several years, we have beenfortunate to partner with a number ofworld-class organizations that have imple-mented a var iety of cost ing and prof-itability analysis init iat ives intended tocreate organizat ional change and ult i-mately improve the bottom line. In eachof the following three examples, this wasthe first cost ing init iat ive to be under-taken, highlighting the “start anywhere”approach.

Leading global f inancia l services com-

pany: Shared services enablement, greater

understanding and transparency. A leadingglobal financial services firm undertooka financial transformation project with theintent of creating a financial shared ser-vices center to support its global needs.As part of this reorganization, which hadthe practical impact of creating a com-pany within the company, a new servicecatalog was established, a cost manage-ment system was developed to determinecost and bill rates, and a new billing solu-t ion was implemented that integratedwith the firm’s enterprise resource plan-ning (ERP) and automated the invoiceprocess . The solut ion gave ser v iceproviders a greater understanding of theimpact of demand on their staffing needsand the metrics to justify those fundingdecisions. It also gave the service receiversgreater transparency into the nature of billedcosts as well as a key understanding of theutilization drivers that impacted them.Exhibit 4 shows an example of a “trace-abi l it y map” that a l lows an analyst toanswer ques t ions about any charge ,enabling greater transparency into theprocess for providers and consumers.

The fol lowing benefits were gained:• economies of scale that boostedperformance and lowered adminis-trat ive costs; and

• improved quality of serv ice.The fol lowing challenges were over-

come:• understanding actual serv iceprovider costs in support of internal“clients”;

• recognizing that charging businessunits for serv ices consumed canhave different results and method-ologies; and

• support ing organizat ional change.Global services organization: Ful ly al lo-

cated P&L — Which bus inesses in which

countr ies were prof i table. A global ser-vices organization with multiple LOBs andmultiple global and regional shared ser-v ices centers init iated a change in exec-ut ive leadership w ith the purpose ofestablishing a renewed focus on prof-itability. One of the first orders of busi-nes s was to conver t the manager i a lreport ing of country and LOB leader-ship from a contr ibut ion margin v iewto a ful ly al located P&L, with the intentof ensur ing that the aggregate of thefirm’s various entit ies matched the over-al l f inancial performance repor ted bythe firm to external stakeholders. As aresult, the firm implemented a multistepallocat ion methodology for both over-head and global/regional support (seeExhibit 5 for methodology employed)using meaningful drivers and ensuringbusiness managers had transparency intothe results . The outcome was that thefirm could determine which businessesin which countries were profitable andwhich were not in order to take correc-tive action. In one example, a lower-mar-g in bus ines s that prov ided va luab leservices to the key customers of a higher-margin business, was absorbed into thelarger business and managed to an over-al l combined P&L.

U.S. outsourcing f irm: Cl ient profitabi l -

i ty and t imely, actionable insight for profit

optimization. A U.S. outsourcing firm thatengaged in mult iyear outsourcing andadminist rat ion contrac ts w ith cl ientsdeveloped a new ana ly t ica l model inExcel® to prototype and assess the prof-itability of its services and clients. Whilethe allocation methodology developed wassound, the amount of t ime to source,cleanse, populate, and validate the inputs,as well as the lack of quality driver datafor certain aspects of the model, createdchallenges. Examples of issues that aroseinclude:• staleness of the data (as much as 12months old in cer tain instances);

47FINANCIAL ANALYSIS SEPTEMBER/OCTOBER 2015 COST MANAGEMENT

WE HAVE BEENFORTUNATE TOPARTNER WITH ANUMBER OFWORLD-CLASSORGANIZATIONSTHAT HAVEIMPLEMENTED AVARIETY OFCOSTING ANDPROFITABILITYANALYSISINITIATIVESINTENDED TOCREATEORGANIZATIONALCHANGE ANDULTIMATELYIMPROVE THEBOTTOM LINE.

. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

• quest ions regarding the accuracy ofthe model due to manual manipula-t ion and lack of meaningful drivers;and

• significant impacts on the produc-t iv ity of analysts who were spendingmore t ime manipulat ing the datathan analyzing the data.We assisted with the development of

a profitability analysis solution that alsosaw the delivery of an operat ional met-r ics data mart and significant improve-ments in the upstream source systemprocesses (like time entry data) that con-tr ibuted to meaningful results. Today,this organizat ion is running profitabil-ity models on a monthly basis for keycustomers and is using the output to helpprice new deals and establish addit ionalcontract language to change more costly,nonstandard cl ient behav ior to moreautomated and standardized means. Costcenter managers are now able to identifyprocess improvement opportunit ies tolower cost per key activity, and the orga-nization has embraced profitability ana-ly t ics as a key component of its cr it icaldecision-making processes.

Some of the actual outcomes of thiscustomer profitability analysis included:• t imely, accurate data for contractrenewal and new business pricing;

• the identificat ion of more costlynonstandard customer behaviors,which resulted in the incorporat ionof addit ional contractual languageand fees to offset them; and

• the establishment of contractuallanguage to incent more desirablebehaviors that resulted in sharedcost savings for both the firm andthe customer.Some of the actual outcomes of the

cost-to-serve analysis were:• a greater understanding of businesscost drivers by operat ions man-agers;

• v isibi lity into employee ut i l izat ionto support hir ing and organiza-t ional structure decisions; and

• the identificat ion of Six Sigmaprocess improvement opportunit ies.

ConclusionHigh-performing organizations are mak-ing continuous planning and profitabilityanaly tics part of their cultures and help-ing to put the “A” back in FP&A. Thefinance organizat ions can be agents ofchange, as they are well suited to explainthe connection between published finan-cial results and the operat ional act iv i-t ies that dr ive them. One way th is i sachieved is through a data enrichmentmechanism that generates a lternat ivemanagement and regulator y P&Ls fordecision-making and compliance, whichall ultimately tie back to published statu-tory results in a transparent way.

In a l l of these examples , f inanc ia ldata enr ichment operat ions ( such asal locat ions and attr ibut ions, t ypical lyfound in t radit iona l cos t account ingprocesses) are play ing a key role in thedelivery of crit ical financial close, man-age r i a l , and ana ly t i c a l app l i c a t ionsthroughout the enterprise. Whether theapplication is intended to support sharedservices cost ing and chargebacks, oper-at iona l t r ans fe r pr i c ing , t r ad i t iona lexpense allocations, management report-ing, or operational analytics, we have pro-v ided examples in this ar t icle of howorganizat ions have under taken differ-ent cost ing init iat ives in order to pro-v ide i nc rement a l v a lue to t he i rorganizat ions. n

NOTES1 Van Decker, J.E., 2010 Gartner FEI Technology StudyResea rch Co l l ec t i on (Ap r i l 2010 ) . Ava i l ab le a t :https://www.gartner.com/doc/1360616/-gartner-fei-technology-study.

48 COST MANAGEMENT SEPTEMBER/OCTOBER 2015 FINANCIAL ANALYSIS