Controlling the Cost of Management Controls

Man fingers setting cost button on minimum position. Concept image for illustration of cost management.

In 1904 Vilfredo Pareto, a noted Italian economist, studied the concentration of wealth in Italy and other European countries and found that 80 percent of wealth was held by 20 percent of the population.  That same distribution was later applied to operations management by management author Joseph Juran in the 1940s.  This has now become known as the “Pareto Principle” or the “80/20 Rule”.  In many instances the populations of many a company’s business transactions takes on the same 80/20 distribution; i.e., 20 percent make up 80 percent of the dollars.  Applying the 80/20 Rule focuses management’s efforts on better controlling high-dollar transactions that have the greatest business risk while allowing for a streamlined process for the rest.  I’ve been recommending and implementing the 80/20 Rule on process improvement projects for my clients for quite some time.  This has resulted in strengthened controls while reducing management time and costs.  This is especially important in the current environment where companies are facing increasing risk management and regulatory compliance costs.

To demonstrate this concept, consider management controls surrounding, say, Purchasing transactions.  A fairly simple analysis of the population of Purchasing transactions will bear out what Pareto taught us years ago; i.e., that 20 percent of the population of Purchasing transactions (POs) will represent 80 percent of the dollars spent by a company.  Hence you can enhance management controls where you spend your money while reducing management time and costs where you do not.

I once observed a CFO who signed all of his company’s POs regardless of their amount.  That CFO had turned himself into a glorified admin who was, in effect, rubber stamping all POs in front of him each day because he simply could not review the volume of POs on his desk.  It would have been far better if he reviewed only the top 20 percent of the POs using an 80/20 analysis.  Then, he could have actually spent the time to understand those high-dollar POs.  All he was really doing was bottle-necking and driving up the transaction processing costs of the entire Purchasing operation while rendering himself useless as a CFO.

Here’s how to apply the Pareto Principle.  Continuing with Purchasing transactions, list out all POs written over a sample period of time by downloading a listing of PO amounts to Excel.  If taking a sample of only several months, you may want to adjust out or compensate for seasonality or business cycle differences.  You should also exclude those types of purchases that are not necessarily pertinent to this type of analysis; e.g., electric utility bills.  Then, add cumulative totaling and cumulative percentages to each row.  It will soon become apparent where the 80/20 break point is located.

Companies often set ridiculously low approval authority thresholds for senior executives and are often surprised at how high the thresholds would if they used an 80/20 analysis.  Often there needs to be an adjustment in the dollar threshold downward to allow for management’s comfort level.  Nevertheless, it is far better to better control those transactions where money is being spent than to waste senior management’s time controlling transactions where it is not.

The Pareto Principle or the 80/20 rule can be applied to a wide variety of other types of transactions as well; e.g., check signing or cash disbursements and many other transaction control points.  It can be used to better control risk management and compliance costs.  In addition, it can be applied to focus customer service and business development to the 20 percent of the customers that represent 80 percent of the revenue.  Hence, better management controls at reduced costs.  All thanks to Vilfredo Pareto!

© 2016, The Fast Track Group, LLC

Our Top-Ten Steps to Cost Reduction Projects

Scissors cutting money bill. vector illustration in flat design on green background with long shadow

Cost reduction consulting is more an art form that involves a solid understanding of the process of change management.  Along those lines, here is our top-ten list for ensuring a successful cost reduction effort.

  1. Obtain senior-level commitment.  Without the CEO’s backing, don’t waste your time!  That means that CEO needs to actively communicate interest, support and willingness to commit resources to the effort.
  2. Establish a sense of need and urgency.  The CEO needs to establish the “burning platform” issue.  This should be easy to communicate as in, “your job depends on the health and survivability of this company”.
  3. Create a guiding coalition.  This is a cross functional team of managers headed up by a project sponsor who would be their direct manager.  One thing to keep in mind when forming up this team, you want people on the team that don’t have the time to be on it, not those who do.
  4. Develop a shared vision and strategy.  This is a subtle but an important first step in establishing a “touch stone” against which all resulting improvement opportunities will be measured against.  If a recommendation doesn’t fit in with the shared vision and strategy, don’t waste too much time with it.
  5. Communicate the change vision.  It is important to establish a project communication program early on.  If the project leadership doesn’t communicate where they are headed, how can anyone down the line be expected to follow?
  6. Empower employees for broad based action.  The team must be empowered to be able to take broad based action.  If the project team doesn’t believe they have the power to change the status quo, they won’t.
  7. Generate short-term wins.  Quick Hits are the key to overcoming initial project inertia.  Find lots of Quick Hits and implement the low hanging fruit quickly.  Nothing breeds success like early success.
  8. Consolidate gains and procure more change.  Once momentum is achieved through lots of Quick Hits early on, the project team will be psyched up.  Now is the time to undertake the more challenging projects that will result in greater paybacks.  Go for it!
  9. Anchor new approaches in the culture.  Once most of the project results have been achieved, don’t stop now.  Keep the project teams intact and focused.  You have a chance to keep it going and anchor change management into the culture.
  10. Hire the right consultant to guide the process.  Although this may seem self-serving, there is much to be said for having an independent professional driving this type of process.  For one thing, a consultant will bring fresh ideas and a willingness to challenge “sacred cows”.  And, there is much cost to be wrung out of those cows!  In addition, change management is something that requires a good deal of neutral meeting facilitation skills.  And, it’s always easier to challenge the status quo when you know you’re leaving after a project is over.

* * * * *

Follow this link for a detailed description of our Fast Track Approach to Cost Reduction Projects: FTG-Approach-to-Cost-Reduction or call us on 917-267-7685.

 

Richard T. Azar, CPA

Managing Member

The Fast Track Group, LLC

(p) 917-267-7685

razar@TheFastTrackGroup.com

www.TheFastTrackGroup.com

 

© 2016, The Fast Track Group, LLC

In Turnarounds Cash Is King!!!

Cash flow analysis on green blackboard with dollar bills

Cash Management is key to survival for any a troubled company.  In fact, by its very definition a troubled company is troubled because it lacks cash — though the reasons for that can be many.  It is said that “a rising tide floats all boats”.  In the military they say, “amateurs talk strategy, professionals talk logistics”.  In turnaround situations my favorite saying is “cash is king”.

One management report that is a particularly important in turnarounds is the “Cash Requirements Forecast”.  This is a relatively simple report to prepare and one that provides senior management with a sound early warning tool to identify an impending cash shortfall.  It can be used by companies of any size, in any industry and even by not-for-profits.  Yet I am always astounded when I come across a new client company with an Accounting team that does not prepare this report.

I was once an interim CFO for a software development company.  It licensed its software on a 90-day site license basis.  For some quirk in the timing of the original sales of these licenses, most of the revenue was booked and collected in the first of a three-month cash flow cycle.  When I began consulting to this client, they had no spending discipline whatsoever so by the third month of each quarter they were sputtering along on cash reserves barely able to make payroll.  I implemented a daily Cash Requirements Forecast report.  Every day I would have it updated and reviewed with the CEO to determine how we were going to collect Accounts Receivable faster, defer discretionary spending or work with vendors when necessary to delay Accounts Payable payments. That was a key report to keeping that company afloat.

The periodicity or frequency that such a report is updated and issued (i.e., the columns shown in the following example) could be monthly, weekly or daily depending on the severity of the circumstances.  It should go out at least as far as one cash flow cycle; i.e., possibly ranging from surplus to deficit back to surplus.  In the example of the software company, I prepared this report on a daily basis for the current month and took it out for two more months on a weekly basis to coincide with their three-month cash flow cycle, then on a monthly basis for a rolling 12 months.  I’ve seen real estate developers prepare monthly reports that went out as far as five years to cover an anticipated real estate development project or development life cycle (of course we all know that the farther out it goes the less accurate it will be).  More likely it would be prepared on a daily basis for the current month and then weekly or monthly for a period going out, say, for a rolling 12-month period.  Figure 1 following presents a very high-level “Star Ship Enterprise” view of what this report looks like.

When Cash Is King

Figure 1: Cash Requirements Report

Financing available will usually take the form of a bank line of credit or in the case of private companies untapped capital calls available from, say, a group of private investors or partners.  In an LLC this will probably be described in the operating agreement.  Those should be shown separately as sources of cash that can be drawn down or repaid.

Naturally, a Treasurer or CFO preparing this report will also prepare a number of supporting schedules to refine and ensure the accuracy of the various receipts or disbursement estimates.  That might include an aged Accounts Receivable trial balance to determine the timing of forecasted collections and an aged Accounts Payable trial balance to determine the timing of payments to vendors.  Regardless of the added work that goes into refining the estimates, it would be inexcusable for a troubled company to try to manage without such a report.  Senior management and the Board should insist on seeing that a Cash Requirements Forecast is used to ensure that potential cash shortfalls are identified early on while action can still be taken to mitigate those risks.

© 2016 The Fast Track Group, LLC.

The Process of Process Documentation

Written process documentation is a key attribute of any system of internal controls.  And, the trend today in auditing, compliance and risk management is towards requiring more written documentation of a wider range of a company’s policies and procedures.  This is not just true for public companies but also for private companies and not-for-profits as well.

Many companies lack process documentation.  This is because the writing process is more involved than just setting pen to paper.  It involves thinking about how you currently do something and questioning whether or not there’s a better way to do it.  And, that gives rise to “change” which is a difficult enough process to manage.  We believe there is no better way to improve processes than to set about to write them down.  It is that exercise that identifies and forces decisions about change.
Too often process documentation projects are assigned to internal teams and fail for a variety of reasons, including:
  • The project is assigned to people that already have “day jobs” with higher priorities;
  • The internal team, though great in their current roles, lack the writing and flowcharting skills, experience or process investigation disciplines required for a process documentation project;
  • The internal team lacks project management methodologies such as documentation formats and templates gained and developed over a large number of similar projects; and
  • Many internal team members will lack the meeting facilitation skills needed to champion meaningful change that may be opposed by colleagues.
Managing change and documenting processes is something we’re heavily experienced at.  We have completed numerous Process Improvement projects (which are all about change management) and the by product of that is always written process documentation.  To prepare that project deliverable in an efficient and timely manner, we have developed a structured approach to process documentation which always consists of two phases of work.  In Phase I we determine the scope of the documentation project and establish the project work plans.  In Phase II we undertake Process Improvement and process documentation.  Here is a highly summarized presentation of our approach.
PHASE I
Develop the Table of Contents
We always start by developing the Table of Contents.  To do this we facilitate a client meeting using white boards and flip charts listing all the processes in a “cradle to grave” order.  This is called “process decomposition” meeting.  The Table of Contents defines the scope of the project and serves as a project road map.
While developing the Table of Contents, we always keep to the rule, “Process titles start with a verb”.  By structuring the Table of Contents so that each line starts with a verb, we are essentially describing in that first word what is being done by that process.  Then, one only needs to scan the Table of Contents to get a good insight to the overall processes.
It is important to develop the Table of Contents at the right level of detail.  Otherwise either the manual is too high level and is useless or too detailed and never gets read.  We usually go down two to three levels of detail only: (1) Mega processes; (2) Main processes; and (3) Sub processes.  Sometimes we combine sections other times we break them apart until we get the right level of detail.  We don’t try to write at the “desk top procedures” level as that is way too detailed.
 
Finalize the Project Plan
Once the Table of Contents has been finalized we now know the scope of the manual to be written by the number of processes listed in the Table of Contents.  We then develop a detailed project plan using the Microsoft Project tool and we also develop a matrix that lists each section of the manual and the various steps to be performed on each section.  We then track our progress against both the project plan and the matrix to identify any section that warrants attention.
PHASE II
Conduct Process Interviews
Only after Phase I has been completed is it time to begin process interviews.  When drafting any new section of a process manual, we begin by interviewing the “Process Owner” or Go to Person; that’s the person that knows the most about how that process is being performed.  That is how we learn how the process is performed within the context of a client’s unique operating environment.  That person might also be a good source of Process Improvement ideas.
Identify Improvements to the “As Is” Processes
Once we have conducted the process interview with the Go to Person, we consider how the process is currently functioning as compared with our experience with how it should be functioning.  We then begin determining how the process should work in a new “will be” environment, not in the “as is”.  After all, we are consultants not scribes and our clients usually don’t bring us in to document what they do, but what they should be doing.
Document the “Will Be” Processes
We have found that the most efficient process documentation format is a combination of flowcharts and narratives.  Think of a two column document with flowcharts down the left and narrative down the right.  We use Microsoft Visio to develop the flowcharts, and copy and past them into Microsoft Word.  The Word document we use is a template with the two vertical columns and with headers and footers already established.  Naturally, there are many timesaving tricks we use in this process and the templates make it goes surprisingly quickly.
Build Team Consensus for Change
We take a highly collaborative approach on each documentation project in order to create buy in for the change we are recommending.  Accordingly, we meet with the client’s project team weekly to review the documentation sections we’ve completed and to build consensus on the process changes we are proposing in order to take the client from the “as is” to the “will be”.
Process documentation is a key attribute of any system of internal controls and auditors, compliance officers and risk managers are more often insisting on proper and up-to-date process documentation.  Process documentation projects are undoubtedly big efforts – usually not well suited to internally organized ad hoc teams.  However, a properly structured and executed process documentation project will lead to the bigger goal of process efficiency and efficacy as a result of the process improvements that are identified during the writing process.
This is a highly summarized version of our more detailed of our process documentation white paper. To view that, please download our white paper in PDF format by following this link to: FTG Approach to Process Documentation.
© 2009, The Fast Track Group, LLC. All Rights Reserved.

last edited on February 2nd, 2009 at 8:00 AM