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Financial analytics in the digital age

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A declining trend

By John Stretch

Proctor & Gamble recently wrote down their investment in Gillette by USD$ 8 billion because “men are preferring beards”. Marks & Spencer has announced the planned closure of over a hundred stores over the next 3 years. The Tongaat-Hulett share price dropped by 90% when the world sugar price plunged. Did these businesses monitor their key indicators – sales of razors, customer counts, global sugar tonnages under cultivation?

The key indicators in finance are FINANCIAL RATIOS, the basic techniques we learnt during the first two years of accountancy training. But the skill area of financial analytics has moved far beyond being able to calculate the ratios, to the ability to interpret the results and use them to predict the future. The software that mines financial data, automates the calculations, and highlights trends and deviations with graphics and dashboards, is already available. The accountants of tomorrow will have coding and statistical skills.

It’s commonly accepted that CFO’s are expected to report not only on the past, but also to provide present and future financial information, and to analyse this information to give insights to managers and directors. As we enter the digital age, finance organisations will be looking for financial professionals with these expert analytical skills, who can harness the power of information technology to interpret data and build predictive models.

Great reporting isn’t about more data, it’s about better insight. Managers want to know how and why actual results varied from plans and targets, and the implications of these variations. Today’s CFO’s use advanced financial analytics to pinpoint deviations, variances and trends.

Future Information tells us what might happen, based on extrapolations and rolling forecasts. The CFO uses a variety of predictive techniques including probability analysis, simulation, modelling, scenario planning and optimisation. And it’s all based on financial ratios.

In finance we need to monitor the trends in all the ratios that measure financial performance, in ten key areas. When we understand these trends, we can use the ratios to develop informed forecasts and scenarios. Financial analytics helps us to use the trends in backward-looking ratios to look forward – to find the stories behind the numbers and use the storyline to make predictions.

THE TEN QUESTIONS THAT EVERY CFO NEEDS TO ASK EVERY MONTH:

1. How is our business intelligence? Are we investing in projects and product-market combinations that generate competitive returns on sales and investment? (Profitability)

2. Are we investing in the right assets? How efficient is our asset utilisation and maintenance? (Activity and Efficiency)

3. Does our track record enable us to borrow low and invest high with acceptable risk? (Leverage)

4. Will we be able to pay salaries at month end? (Liquidity)

5. Is our company an attractive investment at the moment? (Investor returns)

6. Are we growing too fast – or too slowly? What are the risks? (Sustainable Growth)

7. Could we repay our borrowings if the bank called up their loans? (Solvency)

8. Are we consistently beating our cost of capital by an acceptable margin (Value creation)?

9. How well are we managing resources that don’t appear on our balance sheet- people for instance? (Productivity)

10. Which is the most important driver of Return on Investment in our company, and how is it changing? (Du Pont analysis)

You can’t manage what you don’t measure. In most organisations, our accounting systems provide a structured and reliable data base to support our analysis and forecasts. We tend to have greater integrity in our data, which goes back many years further than sales, production or personnel data. Those of us who master the new skills of financial analytics will turn the business conversation from past to future, and become trusted strategic advisors. When you have mastered these skills, you too can add significant value.

John Stretch provides on-line and in-company training in financial analytics. www.johnstretch.com