Building an effective financial steering system

When a company releases a new corporate strategy, finance often starts to scramble. One of the main reasons is that financial structures are not easily changeable and oftentimes lack flexibility. This inflexibility means that finance cannot easily react and change the way data is produced, stored, and analysed. Consequently, the necessary data to steer the strategy implementation is not available or it takes lots of manual effort to create the data. Additionally, the effort to validate the data is can be disproportionate to the little trust managers outside of finance give to the data. The result is that the financial steering system is not properly linked to strategy, which can be one of the biggest hurdles for effective strategy operationalization.

However, this situation does not have to be the case – in fact, there are enough successful companies out there that demonstrate how to align strategy and corporate management. At the core of these companies one notices that they use the ERP-system to their advantage, rather than having to complain about its inflexibility.

In this article, we will shed light on how to derive the financial steering system from strategy and explain how to utilize your ERP-system properly.

Start by translating strategy to a viable financial steering system

Every strategy defines – at least to a certain extent – in which way the company does business, where the company is headed, what its goals and targets are and where responsibilities lie. These aspects of the strategy, together with the plan how the strategy should be turned into operational action, is the basis for deriving the financial steering system.

This derivation should be the top CFO-focus after strategy definition and can be done by formulating the “Operating Model” of the company. This Operating Model should be based on the information the strategy provides. It must be a concise and condensed birds-eye view of how the company operates to implement the corporate strategy within defined areas of responsibility. The Operating Model has to make transparent what the customer segments are and how they are dealt with, how production is structured, how the company performs R&D activities, how logistics and indirect areas are structured and what the ownership or shareholder structure of the company is and how the company should be steered. This condensed view is necessary to gain an overview of the entire operation, make sure all areas of the company are included in the steering system and – probably most important – give a frame of reference in the following activities to not get lost in the details.

Once the Operating Model is complete and agreed upon by the entire Top-Management, it is time to define and specify the financial targets along those defined structures. Usually, the strategy should make assumptions and set financial goals to a certain extent. However, a further clarification can be useful or necessary. The financial steering system should be one of the core elements to operationalize corporate strategy and be a lever that enables strategy implementation. Therefore, it is necessary to create a finance view on the strategy that clearly states the core steering logic (e.g. if the unit is a cost center, revenue center, investment center or profit center) and the financial targets (e.g. revenue, cost, EBIT, ROI, WACC, CAGR or some other financial key performance indicator) for each area of responsibility.

Finally, CFOs must define which information the responsible managers need to fill out their responsibility and steer their units in accordance with strategy. Best practice is to not “guess” what other managers need but to actively involve them in the process. This involvement can simultaneously gain important buy in for the future financial steering system.

Once the Operating Model is derived and the foundations of the financial steering system are defined, it is time to shape the technical structures and value flows accordingly.

Aligning your ERP-structures and value flow with the financial steering logic

What follows now is arguably the most important step: To make the transition from a high-level management perspective of the financial steering system to linking it with the fundamental structures of the ERP-system. The ultimate test if these two are properly linked together: all relevant data and information that is necessary to steer the company in accordance with the strategy can be extracted without additional effort.

To achieve this, companies need to make sure that the ERP-structures represent the strategy and the defined areas of responsibility. Therefore, the ERP-structures need to be built based on what you have learned in the first phase, i.e. the technical structures must be designed in accordance with the data they have to produce. This includes all material, logistical and financial value flows that take place in the ERP-system and important satellite-systems. The alignment of the value flows with the data-requirements and the financial steering system are especially important when the company runs multiple ERP-systems due to the legal entity structure or international business.

To get this alignment correct, the project team should model how the business model flows through the ERP-system(s) and how the value flow creates data and hereby information in the ERP-structures. All business transactions enter the ERP-system at some point and flow through the system until the business transaction is completed. While they flow through the system, they are represented in different postings, on different accounts, on different cost objects and get calculated, surcharged, allocated and much more done to them. Creating transparency of these value flows is key to assess if the way the ERP-system is setup in coherence with the strategy and the defined financial steering system. Based on this assessment, gaps can be identified where information and data is missing or produced in a way that is not aligned with strategy. Now, the task is to remove these gaps by remodelling the value flows and building the right structures in the ERP-system.

For companies that use SAP, there are core functionalities that serve exactly the purpose of aligning value flows with strategy. However, in our experience, not many companies use the functionalities to their full advantage. To setup SAP correctly, one should model the areas of responsibility that were defined in the financial steering system in SAP structures. Thus, creating structures that are directly correlated with strategy. Next, link all value flows with these structures to produce the relevant data for the financial side of strategy implementation.

As an example, a corporation for public infrastructure with several legal entities defined a new strategy which resulted in business units with attached managerial responsibility and financial targets. The business units were not represented by the legal structure and in business unit multiple departments form different companies worked together to form a business unit. Naturally, the corporation’s entire finance and ERP-system was setup along the legal entities. Information on business unit level was only possible by lengthy and effortful manual work. By setting up the structures along the business units and modelling their value flows accordingly, all necessary data got created. Thus, it was possible for finance to have a parallel steering system that included the strategy view (business units) as well as the legal view (legal entities).

Align finance processes and define the methodology how the data is distributed to all stakeholders

To make a financial steering system come alive, it is not enough to simply produce and report data. Instead, it is necessary to have responsible managers deal with the data, numbers, and structures to grow accustomed to them. In our experience, this is best done by setting up the right forward-looking processes (forecasting and planning). The core of an effective forecast process is to identify and assess upcoming opportunities and risks on a constant basis. Therefore, a forecast process should be implemented that represents the strategic areas of responsibilities and that allows to grasp new information in real-time, i.e. every new insight can be entered whenever it is gained. If the underlying ERP-structures are setup correctly, it is now possible to model financial impacts of new insights at any given time, thus, bringing the financial steering system alive. Furthermore, a forecast aligned with strategy and based on ERP-structures is a very efficient basis for the planning process. All the inputs form forecasting can form the basis for planning which then can be supplemented by targets from strategy.

Now, the financial steering system provides all relevant data in actual, plan and forecast figures on structures that are aligned with strategy – which is a very solid starting point for an effective strategy implementation.

However, usually two more steps are necessary to make the most of a new financial steering system. First, CFOs need to (re-)define internal allocations, transfer prices and other internal connections between businesses to create the “correct” results in each area of responsibility. Finance needs to define logics of internal revenue calculation that is in line with the strategy as well as tax laws. If this is done, finance needs to define efficient allocation processes and implement them in the ERP-system to make the financial impact of these internal allocations visible as quickly and precisely as possible.

Second, finance needs to define how the data gets extracted and reported to relevant managers and stakeholders. Only if the right data is easily available and plausible, the financial steering system can be effective. That might happen in the form of standardized reports, self-service reporting, or other forms of data distribution. In different organizational contexts, different solutions can be suitable. However, it is the core duty of finance to define this and make sure that the data is available, plausible, and understandable.

Involve the right people to successfully build the financial steering system

To build a functional financial steering system, the combination of strategy, finance, process, and IT/ERP-knowledge is necessary. Each of these disciplines on its own is difficult enough, but the real challenge is in combining them – this is also where you can create the most value for the organization. A structured approach and the involvement of experts in each field, as well as experts for the integration, are vital to making a financial steering system come alive.

If you want to get more information on how to build a financial steering system and integrate it in your ERP-system, feel free to contact Fabian Winckler (fabian.winckler@www.draxingerlentz.de) or Gerhard Lentz (gerhard.lentz@www.draxingerlentz.de).