5 Indicators That Your Company Needs a Finance Transformation– Growth of Finance Function Expenses Exceeds Revenue Growth
This is the first in a 5-part series of blog posts that will help you identify if your company needs a Finance Transformation. The growth of Finance Function expenses exceeding total revenue growth may indicate the need for a Finance Transformation.
As a component of fixed cost, a Company should strive to have Finance Function expenses grow at a slower rate than revenue. Although fixed in the short-term, Finance Function expenses typically have significant step variable components. This causes Finance Function expenses to be fixed in the short-term as the same resources can manage large changes in volumes (both revenue and transactions) but will require investment to meet long-term requirements if a company continues to grow in scale and depth (many business units, divisions, subsidiaries, etc…).
During times of steady growth, the spend on the Finance Function should increase at a slower rate than revenue. For example, if a company increased sales from $10 million to $12 million (20% increase) while accounting and finance spend during the same time period increased from $200 thousand to $220 thousand (10% increase) the lower accounting and finance expense growth (10% compared to 20% for sales) will drop to the bottom line, increasing net operating profit.
Comparing the Growth of Finance Expenses to Growth in Revenue
The first in the series of potential indicators that your Company may be in need of a Finance Transformation is to look at the cost to perform the Finance function as a percentage of revenue over time. Preferably, it should be looked at on a historical basis on a 3, 6 and 12-month basis. When the 3-month average pierces the 6-month average, a company should begin to investigate causes. If the trend continues and the 3 and 6-month trend pierces the 12-month average, then a full Finance assessment should be performed to determine if the increases are justified. Many times, strategic investment in the Finance function is required to meet the long-term objectives of the Company justifying the increases, but not always.
Frequently, and especially in smaller organizations, the headcount/cost of the Finance Function will outpace revenue in the short-term. This may be reasonable and justified over short periods of time if it is in preparation for expected revenue growth, integration of new acquisitions, new IT systems implementation, creation of new business lines or service offerings or balance sheet recapitalizations such as a debt issuance, or an initial public offering (IPO). Over the intermediate-term (9-12 months) those fluctuations should even out.
If using the cost to perform the Finance function as a percentage of revenue as a benchmark to peers, remember to only look at Companies in the same industry. For example, a retailer’s cost to perform the Finance function as a percentage of revenue over time will be significantly different than an energy or capital goods manufacturer. Many times, it is best to benchmark your Company against its historical average to avoid this type of distortion.
A similar metric can be to take total General and Administrative expenses as a percentage of revenue to determine operational leverage. Which metric will be best for your Company will depend on your needs and access to data.
If after running the numbers, your organization’s Finance function expenses are growing faster than revenue, this could be a potential signal that your organization needs a Finance Transformation.
Microsoft’s Finance Transformation
A Company that has done exceptionally well in its execution of a Finance Transformation is Microsoft. On slide 13 of the below SlideShare presentation, you can see that Microsoft has been able to grow revenue by 89% over the designated period, but Finance headcount has grown only 14%.
What may be most amazing about the above chart is that people think Finance Transformation means headcount reductions. Over the designated period Microsoft had a significant increase of 14% more people from the base period. That is net new Finance positions.
Through leveraging technology, Microsoft has been able to shift its Finance people’s time from task management, transaction and operational execution to deep analytical and strategic thinking, influencing, negotiating and project management. Instead of focusing on boring, mundane, transaction-level work Microsoft’s Finance personnel became business partners, supporting the growth and profitability of the company so it could achieve such record-breaking revenue growth.
Don’t Go It Alone
Planning and effectively executing a Finance Transformation is hard work. It requires executive buy-in, a careful assessment of a Company’s existing processes and procedures, the identification of pain points, gap analysis, prioritization of initiatives and program management. The ability for an existing resource to take this on in addition to their regular duties is a recipe for failure. Using an external partner to work in conjunction with an internal designate produces the optimal mix of internal knowledge and external resources to produce tangible results.
