While almost every business pays attention to financial performance, studies show that small and medium sized businesses in particular frequently do not engage in thorough financial planning – if at all.
This article covers an important aspect of using planning and the continually improving process approach to enhance performance – setting and reviewing objectives, then taking appropriate action.
Reviewing the Importance of Balance
If you read our email articles regularly, you may recall that I occasionally refer to Kaplan and Norton’s concept of a Balanced Scorecard. Interestingly, I recently heard someone discount the Balanced Scorecard during a business improvement presentation with the claim that there is no real balance in business; there has to be clear priorities.
Kaplan and Norton probably didn’t mean balance in an exact and literal way – that there has to be perfect balance in all areas of business. I believe their point is that to be successful a business needs to pay attention to, and work to
improve, all key business areas. They present a basic set of four segments: Customer, Learning & Growth, Internal Processes, and Financial.
According to Kaplan and Norton, many companies pay too much attention to, and guide their business disproportionately by, the financial aspects of their business. Too frequently, they also gauge success only by short term financial factors. Of course financial factors are important. Without financial success virtually no business will be around for long. On the other hand, financial success, no matter how great, will be short lived if a business is not paying attention to satisfying customers or its internal processes.
Financial Objectives Drive Financial Performance
As noted above, all companies pay attention to financial performance, sometimes too much so. But monitoring financial performance is a lagging indicator; it looks at results that tell you how you have done in the previous period. Obviously at that point it is too late to do anything to alter or improve the financial
performance. What really drives financial performance is setting SMART objectives based on clear goals, and then creating detailed action plans or strategies that will lead to the objectives being achieved.
Setting objectives that can be measured on weekly and monthly basis means you are measuring leading indicators of financial performance; numbers that indicate or predict what the end of period numbers will be. Leading indicators provide valuable information about financial performance, and they provide the opportunity to take corrective or improvement action instead of passively waiting to learn results when the period is over.
An Objective Example
For example, if your company has significant cash reserves in investment accounts, setting objectives followed with action plans can improve financial performance in this area. It allows you to actively affect performance instead of just accepting whatever return results happen to occur that year.
Let’s say you set an aggressive but realistic objective of a 5% annual return on account balances. The plan should call for a monthly review of account statements and of how well current account types and providers are helping you reach your objective. If current accounts are not meeting the objective, then the action plan would call for searching out and reviewing other account options in order to find accounts that would meet, or at least come closer to meeting, return objectives. If these accounts meet other criteria (such as insurance and convenience), then funds would be shifted to the higher return accounts.
As this example illustrates, using objectives, leading indicators, and action plans provide the kind of proactive approach that doesn’t leave results to chance. Plus, the same philosophy can be applied to all areas of finance such as cost of capital, days sales outstanding, and inventory turns.
Keep in mind, however, as the Balanced Scorecard approach emphasizes, financial numbers are not the only factor employed in driving a business. Numbers themselves do not mean everything. Consider our above example. If you have a great relationship with a bank and conduct most of you business there, it may not be worth moving a large money market account over one-tenth of one percent. (You may, however, want to mention to the account manager that a competitor is beating their rate.) If there is a more considerable difference that could lead to significantly missing an objective, then it calls for action.
