Ask the CEO or CFO of any small or midsize business if there are ways they could improve their finance function, and chances are you’ll hear something like: “We run pretty lean.”
Look around the offices of the finance department, and you’ll find plenty of evidence to back that up. Everyone is busy, no question, and staffers will often tell you they’re stretched to the max to get everything done.
But activity is one thing, productivity is another. How do you gauge the effectiveness of all that activity? In other words, how do you measure the efficiency of the finance and accounting (F&A) function?
Here are some tried-and-true, widely used metrics that can help you gain that crucial insight:
1. Finance department cost as a percentage of revenue. This is a measure of all the human resource expenses and systems costs associated with the finance function (including allocations for items like benefits, facilities, and supplies).
The companies with the best scores on this metric achieve finance costs of 1.2 percent of revenue or less. The range of performance is wide, with world-class organizations operating at a little over half the annual cost of run-of-the-mill finance departments and with less than half the staff, according to research by The Hackett Group. Performance varies by industry, too. In manufacturing companies and organizations with significant materials or contractor costs, finance department cost can be as low as 0.4 percent of revenue.
This is a critical metric, and clearly finance leaders should strive to keep their costs low, but it’s important to view this data in conjunction with the other measures described below. A low-cost, bare-bones finance operation doesn’t serve a company well if it’s ineffective, and it may not seem such a great bargain once you consider all of the indirect expenses.
2. Cost per vendor invoice. This is a measure of the total monthly cost of payables personnel, allocation of systems maintenance associated with payables processing (such as ERP and workflow tools), costs of payments (e.g., wires), and material expenses (checks, stamps, envelopes and so on).
Companies that perform poorly on this metric can find themselves paying anything from $10 to $15 per invoice, and some may range as high as $20. In contrast, the top performers hold down per-invoice costs to around $5.
3. Days sales outstanding. DSO measures how effective finance is at collecting cash. This key indicator of the health of working capital tends to vary across different sectors of the economy, so it’s important to use industry-specific benchmarks. Alternatively, a company can compare its actual days sales outstanding to its ideal DSO (i.e., the DSO that would result if all customers paid on time per their contract terms).
4. Forecast and analysis production. Here’s an informal metric, or rather group of metrics, that seeks to answer a simple question: Is management getting the data it needs to make informed decisions? For example, do executives receive a monthly forecast along with a variance analysis comparing forecast versus actual results – two reports that are pretty much table stakes for a productive finance function? How timely is the production of this information, and how much of finance leaders’ time does it consume?
While the detailed construction of this measure will obviously depend on each company’s specific situation and practices, here’s a useful benchmark: at high-performing organizations, CFOs spend 20 percent of their time or less on compliance, reporting and other tactical accounting issues, and 80 percent or more of their time on strategy and business analysis.
A comprehensive view of a finance function’s performance would combine all four of these measures, carefully weighing each one against the others. Doing so can throw a highly revealing light on what the function is really achieving. Sure, everybody’s busy. But are they effective?