Its time for risk consultants to be players with the team on the line. Learn how to achieve innovative advantage using the case studies.
Wednesday, April 22, 2009
Your Balance Sheet Is Different
There are very few experts who know how to read a balance sheet and tell you where you are going wrong with your strategy. I am training myself in this art for last 16 years. I have been into Internal Audits and reading balance sheets all through out.
I don't read balance sheets to manage an investment portfolio but to know how a company stands to perform in future and where a little tweaking can help it turnaround and produce breakthrough results for its shareholders.
It's a real fun to read a balance sheet if you connect it with the key decisions taken by the management. You can know how management is performing to create wealth for its shareholders.
Interesting aspect about reading a balance sheet and P&L is when you can spot the concern areas quickly that management doesn't know that it doesn't know.
Once you know that there is something fishy, its time to find answers and reasons. Informed enquiries with management along with knowledge of business and processes, helps you to get to the skin of the issues.
Second task is about communicating what you have read to the management and inspire them to do something about it. That 'something' which you suggest will bring forth new possibilities and higher value addition for the management.
My intense knowledge in Management Audits along with my ability to read financials helps me coach the management for creating higher value.
You talk about better corporate governance, controls, planning, resource utilization, revenue generation, revenue leakage, cost reduction, where you will look first? All involves a closer look into financials. Different people look at financials in a different way.
Auditors look at a balance sheet in a different way. When you do due diligence for M&A, you read balance sheet in a different way. When you read balance sheet from point of view of wealth generation, it's a different ball game. It's strategic and it's innovative.
SMEs can add great value if they get their balance sheet read by an expert. It's important they understand the game of wealth generation. The expert spends few hours with you, visit your facilities, factories, offices and of course your balance sheet and P&L and come out with value adding recommendations that can produce breakthrough results involving turnaround of your business, increased cash generation, increased revenue, reduced cost, reduced losses and introduction to new possibilities of growing.
Reading balance sheet in this economic recession is very important. Read yourself or ask for some help.
If business consultant tells you what you already know then kick him out and invite the one who tells you something that you don't already know.
One of our clients increased their revenue by 200 %. Cost reduction achieved 50%. Asset turnover doubled in just six months.
Do you believe that unwanted situations within an organizations are about 95% related to process problems and only 5% related to personnel problems? In my views, they are 100% related to personnel problems. :) We always assume that everyone in the organization doing their best to do the right things, but everything ends up screwed up. Actually, the root cause of these situations is local optimization with no global thought involved. When we are working 'in' the process we are not working 'on' it. The person managing or owning the business process should have reasonable knowledge of the process he owns, the technology and the people involved therein.
The Plant Manager walked into the plant and found oil on the floor. He called the foreman over and instructed him to have maintenance clean up the oil. On the next day he again found oil on the floor in the same area of the plant. He thought it must be a process problem. To find the root cause of the problem, he asked the foreman why there was oil on the floor. The foreman indicated that it was due to a leaky gasket in the pipe joint above. The Plant Manager then asked when the gasket had been replaced and the foreman replied that maintenance had installed three gaskets over the past few weeks and all were seemed to leak.
The Plant Manager immediately approached the Maintenance and understood from them that they were all bad and Purchasing had already been informed about the faulty gaskets. The Plant Manager then went to talk with Purchasing about the situation with the gaskets. The Purchasing Manager indicated that they had in fact received a bad batch of gaskets from the supplier. The Purchasing Manager also informed that they had been trying continuously for past two months to get the supplier make good on the last order of gaskets that were all seemed to be bad.
The Plant Manager then asked the Purchasing Manager why they were purchasing from this supplier when they were so disreputable. The Purchasing Manager said because they were the lowest bidder when quotes were received from various suppliers and as a process they always purchase from the lowest bidder. The Plant Manager then asked the Purchasing Manager why they are continuing with this lowest bidder and he indicated that he had received the direction from the VP Finance.
The Plant Manager then went to talk to the VP Finance about the situation. When the Plant Manager asked the VP Finance why Purchasing had been directed to always purchase from the lowest bidder, the VP Finance said, "Because you indicated that we had to be as cost conscious as possible!" and purchasing from the lowest bidder saves us lots of money. The Plant Manger was horrified to find that he was held the reason there was oil on the plant floor.
One may find this scenario somewhat funny, and laugh at the situation but it is often all so true in numerous variations when you reach the last Why? doing Root Cause Analysis.
An automobile manufacturing company had stopped production of its X & Y models in three plants for three months during previous year after substantial faulty part incidences. The Company lost the opportunity to produce about 2000 cars each day once the production was stopped. The CEO had asked the Manager Plant Operations to increase the quality efforts for the next business cycle. The Manager Plant Operations was worried as the Company was already being incurring a huge cost on its quality review activities.
The quality problem had been reduced initially after the last year's incident, but the Company started having the same problems again during the current year. The Company was using various quality controls methods but possibly due to high number of input items, complex assembly line and larger supplier base for input items, the quality controlling was proving to be extremely difficult.
A new Management Accountant who joined the Company recently was of the view that cost of quality was being calculated incorrectly on the previous occasions. He started to include man hours spend by the assemblers on an adhoc basis in addition to man hours of quality inspectors to the quality cost. The Management Accountant's logic was 'the assemblers also inspects quality of their own work and do rework before passing it on to the next stage of assembly'.
The Manager Plant Operations became very unhappy with the conclusion as it would mean higher quality costs for him. He approached the CEO with his complaints. He argued that man hours of the assemblers were attributable to the manufacturing cost and quality was a free byproduct of the manufacturing process. Also, he argued against the adhoc method for determining time spent by the assemblers which was allocated to the quality cost.
The CEO was back supporting the Management Accountant's logic. He said that Quality is never an accident, it is always the result of intelligent effort. However, in order to measure the total quality cost correctly for each plant it was necessary to determine how much time the assemblers spent on inspection and repair. So, he instructed the new Management Accountant to send an email to all the assemblers asking them to record the timings henceforth. But, the assemblers were reluctant to reveal how much time they spent on inspection and repair because they were supposed to be able to perform the task properly in the first place, without rework.
The Management Accountant then invited all the Assemblers & Manager Plant Operations at a special meeting held at the head office where he told them to not to fear the facts as hiding from facts is a preparation for failure. He asked, do you all think that if you don't look, the nasty facts will go away. He told that we were also not fair in the last year to not to include cost of business lost of 2000 cars a day for three months to your quality costs. Then with a mild tone, he requested them to allow him for using an automatic stopwatch on the shop floor on an experimental basis for at least three month to do a fact based analysis of Cost of Quality (COQ). Everyone agreed to cooperate in presence of the CEO.
After quality cost of each assembling department had been collected, it become clear that few departments were incurring well-above-average quality cost. The facts provided the Manager Plant Operation the opportunity to achieve substantial quality cost reductions quickly and simply by concentrating efforts on the problem departments. It was realized that Supplier Selection Process was more influenced by price than quality & delivery dependability for many items. The Company also reduced the no. of suppliers and started procuring from single supplier out of the list of approved suppliers who could deliver defect free inputs on time at a reasonable cost.
The curious Rahil approached CEO afterwards and asked him about the blue binder. CEO smiled and told him that during his school days, one of his teacher helped him develop some basic skills. All students had been focusing on homework completion, notebook organization, and planning for long-term assignments. Students who sometimes struggle in school may have difficulties in these areas. For example, a student may be forgetting to write down assignments in class or a student may complete homework but not put it in his or her school bag before going to school.
Binder organization and planning had helped him a lot. One thing that worked for him was color coding of the binders. He told he learned essentially then was taking larger projects and long-term assignments and breaking them down into more easily doable chunks. This also helped in estimating time for completion, sticking to completion schedules, adjusting completion schedules and benchmarking. When report card came out that year, his teacher asked him to reflect on what he did well and what areas needed to target for improvement. CEO told Rahil that being specific, building on successes and backing it up with the structure supported him to keep moving in the right direction towards greater academic success.
Then with a serious voice he told Rahil that do you know How Standardization Affects Competition and Innovation. He told that there is a success story behind the use of blue binder in his organization. The success of his blue binder is similar to other stories of standardization: the evolution of the personal computer industry, local area networking and the Internet revolution.
Then he told Rahil, the story of IBM Personal Computers. Microcomputers existed prior to the release of the IBM PC. So what was it about the initial IBM PC that made it become a de facto standard that served as the basis for the WINTEL (Microsoft Windows running on an Intel or Intel compatible microprocessor) standard still in use today?
There was nothing spectacular about the IBM PC. It was priced higher than other products from Apple and the various manufactures of Z-80 based CP/M computers. Although sporting a "16 bit" microprocessor, the first versions were slower in processing than the 8-bit Z-80 computers. The operating system provided with the IBM PC was a hastily assembled and feature-lacking operating system known as DOS developed by Microsoft.
One clear reason for the success of the IBM PC was that IBM developed it. IBM was the largest computer company in the world at that time. IBM's introduction overnight legitimized a market trend.
The other reason usually discussed was the fact that IBM chose to fully publish the specifications to the hardware and the firmware of the PC. The blue colored binder that contained the IBM Technical Specification became the blue print for a multitude of small startup companies and traditional competitors of IBM. IBM created the first open source product, the IBM PC. Further fueling this openness was the wily negotiating done by Bill Gates and Microsoft. Microsoft convinced IBM to permit them to sell a version of the PC-DOS operating system to other manufacturers, thus creating an overnight de facto standard operating system.
The last reason was market timing. IBM saw the threat caused by the microprocessor and enabling applications, such as word processing and spreadsheets and reacted by embracing the marketplace instead of trying to fight it.
CEO told Rahil that he cannot tell other specific issues and incident about his own organization but he told Rahil to draw an analogy from the story to understand why he was so particular about the blue binder.
Rahil, an entrepreneurial risk consultant recounts a perplexing assignment where he was the third risk consultant brought in to conduct an organisational review and process improvement assignment. As he wanted to know the cause of dissatisfaction for the client on previous occasions, he approached the preceding two consulting firms where he knew a few consultants.
After discussing the client issues with them, he first decided to decline the assignment but then he thought, he also need to know the reasons from the leadership of the company who wanted his services. He asked CEO of the Company as to what are his expectations and how he wanted him to deliver it. The CEO explained that he wanted a detailed report in a blue binder with eight tabs.
He thought, by letting the client to select the type and color of the binder and the template of deliverable, is neither going to challenge his professional approach nor his standards of delivery. So, he accepted the assignment and conducted his own analysis and produced a report in a blue binder. The CEO not only praised the report, but also implemented the recommendations. When customers are not ignored, underestimated and denied, they respond.
What was so special about the blue binder? What was the secret? The curious Rahil approached CEO afterwards and asked him about the blue binder.
CEO of a large electronic products company received an email from his colleague seeking his ratification for some exceptions which were said to be related to some routine activities. CEO, who was not aware of existence of such activities, instead of ratifying, asked for the purpose of carrying such activities in first place and how these were relevant to the business?
On further inquiry, it was occurred to CEO that these activities were not adding any economical value to the business but consuming a lot of time of the company resources. Then he called Internal Auditor of his company who replied that although his role has been enlarged to improve processes but it is impossible for him to know details of each activity carried out in the organization. Not satisfied with his answer, CEO approached CFO to seek his views on current risk management efforts and responsibilities of identifying and plugging such problems.
When CEO came with his query, CFO was talking to his friend, a risk consultant, who had come to his office to meet him. Soon thereafter all three started talking on the subject. The risk consultant recited how a company has implemented activity based responsibility management, the methodology that provided the internal auditor with the ability to identify and eliminate activities that do not contribute economic value to a business. The management techniques have resulted in flatter organizational structures, the elimination of hierarchies, and fewer internal controls. Managers have taken on a new role as facilitators and coaches instead of supervisors. The old, rigid hierarchical structures have little place in the era of innovation and process improvement.
Advocates of process improvement cannot be allowed to arbitrarily dismiss the concept of extensive checks and controls. The new methodology champions audit trails, clear activity definitions, appropriate separation of duties, and well-defined performance measures. New internal controls take the form of information sharing and trust instead of internal controls inherently based on mistrust.
The approach enables management to actively participate in the process of systematically describing activities, decisions that have to be accomplished, and to clarify the responsibility that each plays in relation to those activities and decisions.
After due responsibility charting, issues are required to be addressed as follows:
Can or need the individual(s) stay on the top of so much? Can the decision/activity be broken into smaller or more manageable functions?
Does Individual(s) need to be involved in so many activities? Are they a gatekeeper or could management by exception principle be used?
Should this functional role or activities be eliminated? Have processes changed to point out where resources should be re-utilized?
Does proper segregation of duties exist? Should other group be accountable to ensure proper checks & balances?
Does the type & degree of participation fit the qualification of this role?
After risk consultant stopped talking, CEO smiled and with a pause invited both of them to join him for dinner as it was already 8:30 PM in the evening.
Mr. Kolah, who is working as a Finance Manager, has taken initiative to bring change through innovation in his organisation. Although his bosses have approved the project to be taken up which is real beneficial for the organization, their attitude is not conductive for the proposed project and change management. They instructed him to hire a renowned consulting company whereas Mr. Kolah thinks that the new consulting projects need more energetic, entrepreneurial and innovative consultants. He has tried hard to convince them but failed to change their attitudes.
Attitudes are a collection of value and beliefs around certain subject. Most people try to change other person's attitude without any success. Attitude cannot be changed without changing incorrect values and beliefs first. Unfortunately, we normally have little success in changing attitude. Telling some one to change his attitude never works. Never. Let us consider this specific values and how beliefs create an attitude.
The bosses of Mr. Kolah are biased towards new consulting company as an agent to innovation and change management. Such a resistance is an attitude.
Value: Security and Ego
Belief A: When consultants of know brand are around, I am secured. Belief B: Young consultants have no knowledge of business. Belief C: People other than big consulting are not trust worthy and lack infrastructure. Belief D: How young people are supposed to teach us on how to do business?
Attitude: People of a new consulting company might be OK, but they will not add value as I am not comfortable hiring them.
Solution is to target all incorrect beliefs first while dealing with attitude. Beliefs are sometime build on wrong values, premises and understanding. This is very true also with more experienced higher level management people.
In today's time when information and knowledge is growing at an incredible speed, the gray hair and experience might not be the major drivers for success and innovation. You need to pump in new blood in the process and increase the velocity to escape the gravity of orthodox thinking. Incorrect reasoning, attitude and state of mind of a person should not be a barrier for successful creation of better organizations of the coming times.
A pharmaceutical company was engaged in a process improvement program but unfortunately the processes have not been identified following the principles of execution based organizational structure and value chain analysis, moreover they have been identified without a performance context. This means they were not connected to the business systems or business results.
The pharmaceutical company mapped processes based on its functional view of the organization and the process improvement efforts (mostly Six Sigma) were conducted within its few functions over the past two years. These projects had been initiated because there was a willing functional VP sponsor who was a Six Sigma believer. And, the outputs of the processes in question were relatively easy to measure. Also, there had been customer complaints emanating from some of these processes. Some of the improvement projects were defined by the Company personnel seeking certification.
At the same time when these process improvement projects were initiated, a strategy review by the executive management team concluded that the very survival of the company rested on new product development and a redirected and reenergized sales organization.
Looking from the horizontal or value chain view of the Company on top of the functional view of the Company, one could see that the process improvement efforts executed over the past two years were buried in the 'Delivered' segment of the value chain, while, at the same time, there were lost strategic opportunities for process improvement in areas of new product launching and new sales organization.
Identifying processes within a major functional silo can give the illusion of being linked to business results, but the potential for sub-optimization still looms large. Given this fundamental flaw of processes not being linked to business results via the value chain and organization structure as primary processing system, the following are some of the predictable problems with subsequent process improvement efforts:
First, the criterion for selecting processes for improvement is based on staff's particular interest which might be conflicting with specific business priorities. This will cause three unfortunate results: The first result will be that every improvement effort will have the potential to sub-optimize the business. The second result will be missed opportunity. The third result is the waste of time and money resulting from the projects that were being initiated primarily because there was a willing sponsor or just to demonstrate the power of new management concept by experimenting on a safe, but insignificant operation or someone can get his or her Black Belt accreditation due to such projects. The accumulation of a few projects initiated for reasons such as those mentioned above will soon begin to undermine the process improvement efforts.
In the absence of a connection to business results, the process improvement effort gravitates toward irrelevant process improvement goals. The improvement projects tend to get identified, defined, and shaped so as to best apply and demonstrate a particular methodology. It becomes a methodology in search of a project rather than a Critical Business Issue in search of a solution.
Vice president in the pharmaceutical company believed that the procedural level workflow documentation required by various certification efforts, such as ISO and SOX, is what process is all about. Whereas some in the organization thought that process documentations is similar to IT requirements documentation. Although software made it easier to manage documentation required for SOX and other certification, but this led to the delegation of process documentation to techies and clerks. TQM focused on processes as a tool, taking application of the process notion to the sub-process level within the functions and many staff resources were made process owners in silos increasing organizational conflicts and sub-optimisation. The Six Sigma movement proved to be a rigorous, precise, but costly analysis just to address some unimportant problems buried deep in the organization.
In contrast to the issues identified above, if the processes in a process improvement project to be linked to business requirements, process improvement should work as follows:
A process improvement team identifies an emerging or potential process performance problem. This problem is shared upward with the appropriate level of executive management team or perhaps directly with the value chain management team. The executive management team at the appropriate level assesses the significance of the problem identified by the process improvement team, does a preliminary analysis to determine likely causes and the scope of the problem, and, if merited, initiates an improvement project with a higher ROI. The executive management team uses the cross-functional value chain map to track the location and progress of all such performance improvement initiatives, ever vigilant for possible sub-optimization.
A retail chain was facing a lot of problems with its new ERP system. The management was experiencing missed deadlines, unmet requirements, dissatisfied customers, excessive costs, and underused systems. Although there was no significant system or control failure as per internal audit reports but everything was waiting for a failure to happen and the retail chain was exposed to high risks.
New ERP system had all kinds of bugs and yet was not described as a failure. New ERP system was delivered late, at inflated cost, with inaccurate functionality, and most functions were largely unused. The management could command the resources and had power to sustain it and thus the new system was not considered a failure. The leadership announced successful implementation of ERP as it was serving some of the organizational purposes. System was functional although not perfect.
An interesting distinction needs to be drawn between failure and flaws. Most internal auditors would agree that every information system is flawed in some way or other and that flaws are characteristic of the systems themselves and of the innovation process. However, flaws may be corrected at a cost or accepted at a cost after considering its significance and potentiality to become a root cause for a failure.
Internal Auditors often view the process improvement along with ERP implementation as a mechanical, predictable activity that should, with good project management, lead inevitably to the planned results. However, developing processes along with new ERP have two important dimensions i.e. innovation and support management. Building and maintaining an ERP system is not a routine process, even with the best methods and tools available. It is an innovative process and, therefore, necessarily involves uncertainty.
Politics and human frailties loom large and have an inevitable impact on the outcome of new ERP implementation too. When systems failures or disasters occur, blame is often placed on the users for not acting in accordance with procedures or for not diagnosing a problem quickly enough. In investigations following a major failure or disaster, a common approach is to focus simply on the operational activities as the most likely cause.
ERP implementation should synergies with management accounting needs of the business as decision making is not supported by mere seamless integration of business functions like financials, HR, production, CRM but dynamic management accounting principals. If you can't see the entire picture, you have disconnects between strategy and people processes.
Current Enterprise wide resource planning and management puts reality behind the numbers. ERP should specify how the various moving parts of the business will be synchronized to achieve the targets, deal with trade-offs that need to be made, and looks at contingencies for the things that can go wrong or offer unexpected opportunities. Do your business managers refer to ERP at the time of making a decision? If not then what is the use and yield? The business managers should be able to see preview of his/ her proposed decisions.
Innovation and lateral thinking is missing in the entire process. ERP needs to rendezvous with knowledge of business, with management accounting.
Best practices are like benchmarks. They are very personal and contextual. Applied incorrectly, best practices can become handcuffs. People say let's apply best practices to help improve the processes. We always look at what has worked for others and try to repurpose it for our requirements. Does that make it "best practices," though?
Best practice like Just In Time (JIT) inventory system is not just an attempt to maintain minimum or zero inventory. The JIT process involves fine tuning production and supplier scheduling systems, where inventories are supplied when needed in production and monitoring the entire value chain closely to reduce wastage and minimize inventory buffers.
An US company had known about JIT used by its Japanese counterparts with assembling cost below 20 % of its own. In an attempt to replicate the success, US Company too then implemented JIT. Although it was successful in reducing its assembly cost noticeably, it experienced dramatic problems with its major suppliers at the same time. They begun to demand price increase that more than offset the assembly plant cost saving. The company blamed its suppliers for not using JIT concept for their own operations. However, the problem was different and not realized by the US Company initially.
While the US Company reduced its need for buffer stocks, it placed major strains on the manufacturing responsiveness of its suppliers. The reason was very simple. The assembly plant of the US Company was experiencing huge and uncertain variability in their production schedules which made the manufacturing for its suppliers a nightmare. Management had ignored the idea that JIT involves partnering with suppliers down the value chain. It did not realize that the key in the success of JIT for Japanese assembly plants was schedule stability for its supplier firms.
A knowledgeable risk consultant can play important role in implementing and maintaining innovative management accounting systems like JIT, ABC & Six Sigma. The risk involved is of making incorrect planning decisions and control decisions.
Nowadays activity-based costing (ABC) is being adopted as an alternative cost accounting system that supposedly overcomes the deficiencies of the traditional cost accounting system. However, ABC has been abused by its users. It is now clear that one should understand it from Activity Based Management and strategic perspective and should not use it as an accounting system by bringing it in the general ledger system.
Proper Risk Consulting may contribute to the success of new management accounting concepts through several types of involvement: (1) audit of cost drivers, (2) audit of non-financial performance metrics, (3) Value Chain Analysis, and (4) audit of value added by ABC.
This is the future area where maximum value addition can be achieved and requires different approach in risk consulting.
Risk exists if you are not aware and not implementing a new management tool and technique when your competition is. Risk exists if you are implementing it incorrectly and your benchmarking analysis is flawed and not showing you the key factors causing the performance difference between you and your competitor.
There are very few experts who know how to read a balance sheet and tell you where you are going wrong with your strategy. I am training myself in this art for last 16 years. I have been into Internal Audits and reading balance sheets all through out. 
