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Copyright Thomson Tax and Accounting d/b/ an RIA Jan/Feb 2007
With much of the Sarbanes-Oxley compliance effort now behind them, chief financial officers are using a suite of methodologies that are comprised of business performance management to address new challenges.
Over the last few years, chief financial officers (CFOs) have concentrated a great deal of attention on ensuring the successful implementation and operation of compliance-related initiatives, most notably the Sarbanes-Oxley Act (SOX). But with much of the effort to meet these regulatory requirements now behind them, CFOs are returning to a traditional mandate-performance management-in the context of the unique challenges presented by a heavily regulated, post-SOX environment. Chief among the approaches CFOs are using to address these new challenges is a suite of tools and methodologies that fall under the heading of business performance management (BPM).
Business performance management
BPM, also called enterprise performance management or corporate performance management, refers to the continuous monitoring and management of enterprisewide business performance through a tightly integrated system of people, processes, technologies, and measures. The scope of activity contained within BPM encompasses all the processes associated with budgeting, planning, and forecasting, financial and management reporting, performance monitoring (via scorecards or dashboards), financial analysis, and modeling.
Although the concept of BPM has been with us for a while, implementing it is more feasible for CFOs today because of a number of conditions created by the post-SOX environment.
An improved, harmonized reporting regime. One of the traditional challenges of implementing BPM has been the need to create a tightly integrated financial reporting structure that could assure the consistency of the processes that produce reported results across functional units. As a result of Sarbanes-Oxley, CFOs have had to deepen their understanding of the internal controls and processes involved in recording and measuring financial performance. This deeper understanding of enterprise-wide financial-performance reporting processes has provided the collateral benefit to CFOs of highlighting where inconsistencies, inefficiencies, or gaps in these processes lie, along with what is required to harmonize them.
Increased demand for transparency. Historically, CFOs tried to justify the investment required for BPM initiatives by attempting to link explicitly the value of better information to the improved performance (i.e., lower costs and/or greater revenue) arising from better decision making. Although this objective continues to be valid today, the post-SOX business case for BPM investment has been strengthened by the requirement for organizations to meet an increased demand for transparency. Virtually all stakeholders (e.g., shareholders, analysts, board members, executive management) are demanding better visibility and a clear demonstration of how strategy directly links to operations. This requirement is well met by BPM processes.
Better data, better tools. As part of the overall SOX-driven improvements to financial reporting, companies have invested substantially in data cleansing and availability processes. Other regulatory initiatives, such as the Basel II Accord in the banking industry, are creating data warehouses with unprecedented levels of data quantity and quality. At the same time, BPM vendors have made great strides in enhancing their tools to facilitate ease of use and effectiveness. This powerful combination of better data and better tools has provided organizations with a strong foundation on which to realize BPM`s full potential.
The heightened focus on decision support by finance. In addition to ensuring more rigor and detail in explaining historical performance, SOX and other compliance-related initiatives have increased management`s expectations for gaining earlier visibility into where and when the organization might encounter financial or operational difficulties in the future. To meet this expectation, the finance function`s agenda has shifted from being compliance-dominated to one that better balances control activities with the reemergence of an important decision-support mandate. As a result, BPM initiatives are receiving the appropriate senior-level sponsorship and visibility necessary to succeed.
While the conditions for successfully implementing BPM in today`s business environment are very close to ideal, a number of challenges remain for organizations embarking on a BPM initiative. When we look more closely at these common challenges, we see that the majority are either process- or people-related. At the same time, we see that forward-looking organizations are adopting leading practices that effectively address these issues.
Rethinking fundamental processes
Of the business processes most central to implementing BPM successfully, three stand out as critical to effective performance management. These processes are budgeting, planning and forecasting, and key performance indicator (KPI) selection.
Budgeting. The budgeting process is a common source of frustration for companies moving to the integrated performance-management model demanded by BPM. When the budgeting process is ineffective and unduly complex, underlying corporate strategy and key objectives get lost within the details, bogging down both the finance department and its clients with an overreliance on disconnected spreadsheets that contain inconsistent assumptions. As a result, the budgeting process consumes too much time and delivers too little value as companies expend effort on low-value-added activities such as data consolidation, reconciliation, and rekeying.
Because of these issues, and the fact that budgeting "front ends" the performance-management process, leading practice organizations often tackle the budgeting process first as the kick-off to a broader BPM transformation effort. Efforts to improve the budgeting process focus on reducing process complexity-by, for example, reducing the number of line items within the budget to a smaller, manageable number of key performance drivers. Leading companies also emphasize the need to simplify the consolidation and reconciliation by reducing reliance on spreadsheets through the use of BPM applications that utilize Web-based, collaborative solutions.
Planning and forecasting. The most common issue afflicting traditional planning and forecasting processes relates to weaknesses in communicating high-level strategic objectives to business units. Frequently, the communication that accompanies the planning and forecasting process is both too brief and lacking in clarity, which hinders the opportunity for constructive analysis and debate between management and the business units. As a result, business units often come to perceive the process as a low-value administrative exercise rather than one that can yield valuable insights into managing business performance.
Another reason traditional planning and forecasting fails to add value is that many organizations execute these processes only once a year. This prevents them from leveraging the experience and market knowledge that business units have gained throughout the year, which is critical to conducting effective BPM.
To address these challenges, leading practice organizations implementing BPM are increasingly moving toward continuous or event-driven planning and rolling forecasts. In the process, they are abbreviating the fiscal-year planning cycle while strengthening the quarterly cycle to include, among other things, a review and refinement of the annual corporate funding decisions.
By rethinking planning and forecasting processes in this way, management provides a greater opportunity for business units to discuss, clarify, and absorb corporate strategy and key objectives, thereby allowing front-line managers to react that much more quickly. From a target-setting perspective, BPM approaches such as driver-based planning marry external data points with internal analytics to facilitate a speedier agreement on meaningful targets.
Selecting and cascading KPIs. No process more starkly contrasts traditional performance-management approaches with BPM than the selection and cascading of KPIs. Recent surveys indicate that organizations, on average, track nine times more measures that are actually needed. That`s because traditional approaches to KPIs follow a "more-is-better" philosophy. A BPM-structured approach, in contrast, stresses a "less-is-more" mindset. It favors the selection of the few measures that most directly drive an organization`s strategic intent.
Another challenge of implementing BPM-inspired KPIs lies in moving away from traditional performance-management approaches, which produce an overreliance on financial measures. Despite widespread exposure to methodologies such as Kaplan and Norton`s balanced scorecard, which emphasizes equilibrium between financial and nonfinancial measures, the bias toward financial measures persists, largely because of a tight coupling of financial measures with the core elements of an organization`s executive compensation plan. Further compounding these biases in today`s environment are the many regulatory compliance initiatives, such as Sarbanes-Oxley, that emphasize financial versus operational measures.
Finally, compared with the loose linkage of KPI measures and strategy and objectives contained within most organizations, adopting a BPM approach to KPIs requires the implementation of a rigorous methodology to ensure strong alignment and proper cascading of measures throughout the organization.
Leading practices for implementing KPIs begin with a focused effort to consolidate and reduce the number of KPIs-in the range of six or seven on the low end and up to fifteen at the high end for an individual or process. Ultimately, the actual number should be determined by factors such as a company`s culture, its financial stability, industry volatility, the economic environment, and the organization`s ability to monitor and assign accountability for the measures adequately. A reliance on exception-based reporting and analytics is a useful way to help reduce the number of regularly tracked KPIs. Such tracking is a way to alert management when key metrics (though not KPIs) move outside predetermined thresholds. These are sometimes referred to as "sleeping alligators" and should also be kept to a small number.
With respect to the type of KPIs selected, leading practice involves taking a structured approach to KPI selection by testing a proposed KPI measurement set against considerations (see Sidebar). Organizations should focus on ensuring that "lagging-indicator" financial measures are balanced with "leading-indicator" measures, such as market share, customer satisfaction, customer churn, and employee turnover.
With respect to the cascading of KPIs, leading practices involve using three main types of cascading methodologies, depending on the degree of alignment between a given business unit and the enterprise. These methods include the following:
* Identical cascading: Business-unit objectives and measures are identical to those of the enterprise.
* Complementary cascading: Business units support the enterprise`s objectives and measures but may not mirror them directly.
* Unique cascading: Business units have unique needs that are not shared by the enterprise but are significant enough to be captured as a metric or KPI at the business-unit level.
Driving performance and productivity
The people issues related to implementing BPM center on how to improve personal performance and productivity by addressing three aspects of traditional performance management: improving the performance-evaluation processes, increasing business-unit accountability, and increasing business skills within the finance function.
Improving performance evaluation. Traditional performance-management processes base performance evaluation on fixed targets that are created at the beginning of each fiscal year. This can often result in the following issues:
* Targets` becoming out of date based on company, industry, or economic events.
* Inadvertent promotion of "gaming" activity that significantly extends the budgeting and forecasting processes.
* A reduction in the incentive to perform if targets either are met or perceived to be unachievable.
Within a BPM framework, performance evaluations become based, instead, on relative performance. For example, they may be measured against the previous year, competitor peer groups, or external benchmarks. Any short-term or interim targets should be set for the sole benefit of the business unit rather than used as a performance gauge by management. Management should track a few select KPIs and then intervene only when a negative trend or significant downturn occurs. The goal is to achieve an environment of support and development rather than instill one focused purely on control.
Increasing business-unit accountability. Traditional methods of imposing "top-down" plans and targets on business units tend to remove accountability ("they weren`t my numbers") and decrease motivation. In contrast, a BPM-driven approach to instilling business-unit accountability repositions management in the role of providing guidance to plans that business units have developed and are executing.
One such approach might begin by having management develop or refine strategy maps depicting desired outcomes and supporting initiatives for the company`s strategic goals. Once this activity is completed, management would craft medium-term goals tied to value creation (two to three years out), along with directional spending parameters (for example, by setting upper and lower boundaries).
This information would then be passed on to the business units, where the plans are developed for, and adapted to, unit-level needs within the broader corporate objectives. The result is that business units assume greater accountability and ownership overspending while shedding the "spend-it-or-lose-it" mentality so common to traditional planning processes.
Increasing business skills within finance. In traditional performance-management processes, the finance role is often viewed mainly as an internal watchdog that ensures compliance with both policy and process. This business-unit view may prevent the finance function from adding valuable insight into important areas such as investment prioritization, process improvement, and the establishment of planning targets.
To succeed in transitioning to BPM, the finance function must be repositioned as a valued business partner. Its ability to provide insights and analysis to business-unit leaders can be strengthened through a combination of specialized training and rotation of finance staff through various business units to deepen their understanding of the organization`s operation.
In reality, the financial services industry has understood the promise of BPM for some time. However, the conditions necessary to realize its potential successfully have been less than ideal. Today, however, as CFOs emerge from their compliance-dominated agendas of the past few years, there is a realization that the post-SOX environment presents a unique opportunity to transform traditional performance-management processes through the methodologies and tools encompassed in BPM.
By focusing on the specific process- and people-related issues required to transition to BPM, organizations can rethink discrete and fragmented legacy practices to meet the pressing need for integrated and timely performance management demanded by stakeholders.
ANOTHER REASON TRADITIONAL PLANNING AND FORECASTING FAILS TO ADD VALUE IS THAT MANY ORGANIZATIONS EXECUTE THESE PROCESSES ONLY ONCE A YEAR.
DESPITE WIDESPREAD EXPOSURE TO METHODOLOGIES SUCH AS KAPLAN AND NORTON`S BALANCED SCORECARD. THE BIAS TOWARD FINANCIAL MEASURES PERSISTS.
KEY CONSIDERATIONS IN SELECTING KEY PERFORMANCE INDICATORS (KPIs)
An effective KPI should be as follows:
* Explicitly linked to a strategic objective and outcome-oriented, as opposed to measured strictly on inputs or outputs.
* Tied to a decision-making process with a specific owner.
* Aligned with the company`s reward system to reinforce desired behavior.
* Target-based, with a time-based target value, such as a medium-term goal.
* Rated and have thresholds that grade the difference between the actual result and the target value.
* Presented within a trend line rather than as a single digit on a dashboard.
* Subject to annual regression/correlation testing to ensure alignment with the organization`s strategic objectives. On average, 10% to 15% of KPIs change annually.
* Appropriate to the various levels within an organization:
-Business processes should focus on end-to-end process results (not activities) using operational KPIs.
-Business units should be tied to strategy and should focus on unit results, using a combination of operational and financial KPIs.
-Corporate management should be tied to investor and key external stakeholder expectations and use primarily financial KPIs.
PAUL BATTISTA is a partner and TIM SHEA is a senior manager in Ernst & Young`s Financial Services Advisory practice in Toronto, Ontario.
Indexing (document details)
Subjects: Performance management, Corporate management, Chief financial officers
Locations: United States, US
Author(s): Paul Battista, Tim Shea
Author Affiliation: PAUL BATTISTA is a partner and TIM SHEA is a senior manager in Ernst & Young`s Financial Services Advisory practice in Toronto, Ontario.
Document types: Feature
Publication title: Corporate Finance Review. New York: Jan/Feb 2007. Vol. 11, Iss. 4; pg. 31, 5 pgs
Source type: Periodical
ProQuest document ID: 1264287931
Text Word Count 2441
Document URL: http://proquest.umi.com.ezproxy.apollolibrary.com/pqdweb?did=1264287931&sid=2&Fmt=3&clientId=13118&RQT=309&VName=PQD