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Advice and Information for Finance Professionals

Cloud ERP: Show Me the Money

Guest Author

By Jim Maholic, Business Value Services, Oracle

Jim MaholicAs stated in the first post in this series, a business case is about business. We’re in the middle of unpacking the four components of the business case, which are:

  • Hypothesis
  • Evidence
  • Analysis
  • Recommendation

We covered the hypothesis and the first stage of gathering evidence in prior posts. Now we need to dig a layer deeper and start analyzing the evidence, building a case that shows the potential value in your proposal.

To show that there is value in your proposal, it’s important to answer three vital questions: 

  1. Where does your company have areas needing improvement? 
  2. How will your proposal deliver this improvement?
  3. What is the measurable, financial value of that improvement? 

Most technical professionals are quite capable of addressing the second item—explaining how their proposal delivers improvements. Where most need help is with the first and third items. 

We will operate under the assumption that your company wishes to be a market leader, not just in product leadership and market share, but also in profitability and cost containment. After all, the better a company controls its costs, the better it can either compete on price or keep prices steady and generate more profit for investment in R&D or acquisitions. Your proposal, to be effective, must show where such unlocked value resides and how your plan releases it.

Where might we find truly sustainable, measurable financial value? There are three high-value areas where such value can be uncovered. Think of this acronym: P-T-I. PTI stands for Peers, Trends and Incrementals. We’ll explore each of these in brief.

In this exercise, we are going to use the company’s own, published financial data to tell a true and compelling story. This takes a little desk work on your part, but it pays huge dividends for you in terms of credibility and professionalism. To complete this exercise, you’ll need your company’s most recent annual financial statements (Balance Sheet and Income Statement, or SEC form 10-K) and those of three of your company’s closest competitors. (You can find these on the Investor Relations page of the company website.)

Peers – External Peer Comparisons

Every company has different strengths and weaknesses compared to its peers; therefore, this exercise is not a one-size-fits-all example. You must apply some artful analysis along with your scientific-like research. For your external peer comparison, compare your company’s performance with the performance of your nearest peers. Pick three (or more) publicly-traded peers and download their most recent SEC annual financial statement, the 10-K. Build yourself a handy spreadsheet similar to the example shown below. If your company is not publicly-traded, ask your CFO for a copy of the most recent annual financial statements. Then compare your company to three (or more) public peers in your industry.

Peers - External Peer Comparisons

To build your spreadsheet, enter data for the most recent year and one year prior. Do this for the four companies in your comparison. From the spreadsheets, build a quick summary snapshot showing all four companies side-by-side as in the example above. The top half of the summary simply reflects the data you entered. The bottom half of the summary (Sales and Costs) requires you create simple equations to make your comparisons easy.

Reviewing the above summary, we observe several things. All companies had declining sales in the past year. And your company (Company X) fared next-to-best by comparison. That’s a good thing. But look at Cost of Sales as a Percent of Sales (for non-accountants, Cost of Sales are the costs associated with manufacturing your products). Your costs as a percentage of sales are significantly higher than all of your peers. That’s worth exploring. Next, all three peers were able to reduce their SG&A (sales, general and administrative costs) as a percentage of sales but you increased yours (see SG&A growth). That’s another topic worth discussing. 

Trends – Internal Year-Over-Year Trends

Now focus your attention solely on your own company and its performance over the past year or two. The biggest thing that jumps out from this analysis is that while sales declined, SG&A expenses went up. That’s also worth exploring.

Incrementals – Finding Value in Internal High-Value Areas

This may not show up on individual financial statements, but invest some time to explore the highest spending categories in your company. In a manufacturing company, the purchase of raw materials is often the largest annual expense. In our example we see Inventories totaled $2.033 billion. For this exercise, we will assume 25% of inventory is raw material; that would represent roughly $500 million. If a technological solution (such as cloud supply chain management) could help buyers make better purchasing decisions, your proposed solution might help the company save 1-2% in raw materials alone. If that were true, that 1% savings might yield $5 million annually. You can run these incremental estimates on any high-value area with similar results. 

Let’s review.  In these three examples we highlighted four potential discussion points:

  • Your company’s Cost of Sales as a Percentage of Sales was higher than your peers
  • Your SG&A as a percent of Sales increased while all peers were able to decrease theirs
  • SG&A expenses went up while sales actually went down during the same time period
  • Potential savings in purchase of raw materials could be gained through better negotiating, stronger controls, and improved supplier qualification

 With these four benefit conversations, we now have something truly tangible to discuss. 

Admittedly, we do not have concrete evidence explaining why these things have occurred. We’ll explore that in a future post when we address the concept of negotiating the value of benefits with business unit managers. For now, this is where we need to focus. Dig in and explore where the company underperforms against its peers and where it has performed unfavorably year-over-year against itself. Consider asking yourself and the responsible business area managers these questions:

  • How could my proposal deliver value to this area?
  • If it does deliver value here, how much will it impact this line item?
  • What do our competitors do that make them more efficient than us? What can we do to become more efficient and competitive?
  • Why are our costs going up while our sales are going down? (Keep in mind that there may be a very reasonable explanation for this, such as higher-than-usual office lease expenses or expenses related to an acquisition that were not capitalized, etc. Don’t assume this is bad and pounce on it. Ask questions and learn.)
  • Which purchased items could we re-evaluate and possibly re-negotiate for better pricing in future purchases?

In the next article we’ll look at my favorite area to find value: working capital. Working capital often seems to mystify non-accountants. Fear not, it’s not complicated. And together, the combination of working capital and the items discussed here will launch your business case towards success.

Missed the previous post in this series? Read it here: “Gathering Evidence for a Winning Business Case.”

Business Cases that Mean Business

This post is the sixth in a series of twelve articles excerpted and adapted from my award-winning book, Business Cases that Mean Business.

Developing a business case is simply the identification, calculation and communication of the value of your proposed capital expenditure. Creating a sound business case should not be intimidating. You simply must approach the development of a business case with discipline and ample planning. This series of articles will give you an overview of the creation of a successful business case. If you wish to explore this topic deeper, or just jump ahead right away, check out my book.

The next article in this series will be “Time Really is Money: Demystifying the Cash Conversion Cycle.”

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