Enabling the CFO as the Chief Profitability Officer Across the Company to Manage ROIC and EVA

Curtis Mahanay, C.P.A., C.I.T.P.Senior Functional Consultant

• Goal of webinar• CFO’s Perspective and Need in New Normal• Success of Cost & Profitability: Defining and Mapping Key Metrics• Phase I – Driver-Based Contribution Margin for Profitability

Management• Phase II - Integrating Driver Base Contribution Margin with ROIC• Phase III - Integrating Planning• Phase IV - Integrating Advanced Analytics• Architecture and Key Technology (OLAP)• Conclusion and Q&A

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Contents of Webinar

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Goal of Webinar

Goal of Webinar: Provide CFO Information To Make Decision

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• Provide relevant information about Cost & Profitability• Summary – Webinar• Detail – Blog (link to follow)• Financial prototype (available upon request)

• Develop business case for cost & profitability as part of EPM• Find profit dragons affecting

• Contribution Margin• ROIC

• Enhance Finance planning and close process

• Validate use of Cost & Profitability and expertise…is it proven?

• Provide Industry specific examples

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“Virtually everything in business today is an undifferentiated commodity, except how a company manages its information.

…how you manage information determines whether you win or lose.“

Bill GatesMicrosoft

You can’t manage what you don’t first measure…..therefore, turning datainto information faster than your competitor should be goal #1….

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“By leveraging our reservoir knowledge, we created life-of-the-well solutions to drive down drilling and completion times and to increase operational efficiency.“

Halliburton ‘10 Annual Report (future strategy around managing decline curves)

“The incentive problem in higher education that inhibits cost control is the same incentive problem that leads to scandals and bankruptcies in the for-profit sector and that contributed to the current financial crisis.”

The Revenue to Cost Spiral in Higher Education – Robert E. Martin

“Hospitals need revenues to finance operating expenses, to invest in new capacity, and to provide charity care for the uninsured, yet they receive payments from public insurance plans that lag behind the growth in the costs of care. Positive contribution margins on orthopedic and cardiac procedures for privately insured patients can be used to subsidize less remunerative procedures and patient groups. The average total margin for US hospitals in 2008 was 2.8%, according to American Hospital Association data, indicating the extent to which the double-digit contribution margins documented here are used to support other services. The extent to which the margins documented here are too high, too low, or just right depends on the mandates placed on hospitals by public policy, private litigation, and cultural expectations.”

Hospital Market Concentration, Pricing, and Profitability in Orthopedic Surgery and Interventional Cardiology James C. Robinson, PhD

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CFO’s Perspective and Need in New Normal

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Studies show that 50 to 80% of companies’ CUSTOMERS are “unprofitable”. They are subsidized by the profitable ones.

The key to profitability, growth, and competitive market advantage is understanding…

WHERE the profit dragons areWHAT the trends areWHY they are occurringHAVING a strategy to deal with themAnd managing the (customer, supplier, product) MIX.

CFOs Need To Understand Profitability in Real Time

80% of change in ROIC and EVA is due to Change in Contribution Margin (Operating Ratio)….due to lack of managing customer

profitability

Questions CFOs Ask

• Are We Using Analytics?• Do We Share the Same Data Across the Company?• Are We Measuring the Right Things?• What Are the Key KPI’s and Who should “act” to manage them?• Are We in the Forecasting Drones?• If We Are, How do we change?• Do we “really” have a handle on cost?• Do we strategize from the top or rationalize the bottom?• Are we moving the corporation forward or watching from the

sidelines?All Questions Lead to Operating Ratio, Contribution Margin and/or ROIC at a granular level where you manage your

business 9

Skill Set CFOs Looking for to Answer Questions!

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Success of Cost & Profitability in Managing ROIC : Defining and Mapping Key Metrics

Answering CFO Questions – Process Flow

Mapping the drivers Across the company is the first

step.

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Manage

Measure

Driver Base ForecastingLean Accounting

Financial Strategy, Planning and Close Should Start with Cost & Profitability

Managing Business Performance Starts with Understanding the Business Process

You can’t manage “strategy” if you don’t first measure Op Ratio & ROIC using cost & profitability management

Only the Diagrams are a Copyright @ 2008 Oracle and / or affiliates. All Rights Reserved.

Revenue Source and Key Driver

Transportation

Rail, Truck, Air CargoPrimary – Train

Secondary - Waybill/Unit

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HealthcarePrimary – Department

Secondary - Patient

GTMS

Patient Days

Oil & Gas Exploration Primary – Reservoir Secondary - well Reserves (bbl.)

Higher EducationPrimary – Department Secondary - Student Student hours

ManufacturingPrimary – Customer

Secondary - Sales Order

Direct Material, Direct labor,

Overhead

Industry Revenue Source Key Revenue Driver

Start looking at Revenue Source as a Profit Center versus a Cost Center

Overview: Economic Profit Model (Trucking Example)

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Point of View Operational Drivers - Primary Key Revenue DriverOperational Drivers -

Secondary or Derived Contribution Margin Finance Primary Drivers

Product Type and

Lane (Origination

to Destination)

HistoricalTons per Truck by Product

Units (waybill)

Avg Length of Haul by lane

RTM / GTM Ratio

Operating Ratio

Terminal DwellTime

Capacity by Lane

GTMS

Historical Gallons perGTMS

Gallons(GTMS * Gallons per GTM)

Fuel Expense(Gallons * Fuel Price) +

Effi ciencyFuel Price

Optional by Expense - For Fuel

N/A

Revenue

Fixed CostTax

Labor

Repairs

Capital

NOPAT

ROIC & EVA

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Phase I – Driver-Based Contribution Margin for Profitability Management

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Contribution Margin: Manage by Family/Individual

Direct Cost

Medical

Auto

Home/Utilities

Food

Indirect Cost

Entertainment

Primary – FamilySecondary - Individual

Tuitionl

What is good in managing a family…..

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Contribution Margin:Manage by Department & Patient

Direct Cost

Ambulatory

Surgery

Nursing Care

Physician

Admin and legal

Indirect Cost

Lab

Pharmacy

Cafeteria/Food

Facility &Utilities

Primary – DepartmentSecondary - Patient

…is good in managing business

Step 1: Driver-Based Contribution Margin

Gross Revenue

From

Sales Invoice,

Waybill

Key : Since Contribution Margin is calculated using underlying drivers, you can answer the CFOs question of “why” something changed

Driver Based

Contribution Margin

ExpenseCalculated

Using Key

Drivers

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Example: Driver-Based Expense Calculation for Fuel

Change in Gallons per Key Driver

Key : All Revenue and Expenses have three main components – Volume, Price/Rate, Mix/Efficiency

Change in Fuel Price *

Prior Volume

Change in Volume *

Prior Fuel Price

Calculated Fuel Expense due to Efficiency

Calculated Fuel Expense due to Price

Calculated Fuel Expense due to Volume

Fuel Expense

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CFOs WANT MORE DETAIL TO UNDERSTAND GAP….

IN REAL TIME TO DETERMINE PROFIT “DRAGONS”21

Source:

Cost & Profitability:Contribution Margin View (Non-Driver Based)

Driver-Based Contribution Margin:Revenue/Expense Components

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Variable Definition

Profitability Ratio It is defined as the ratio of a firm’s sales revenue to its expenses during a time period.

Productivity Ratio (Volume) It measures the efficiency of business processes by comparing the actual usage of inputs to a benchmark measure of inputs based on best practices or industry averages.

Capacity Utilization Ratio (Efficiency) It measures the efficiency of a firm in utilizing capacities of fixed resources.

Product Mix Ratio (Mix) It reflects improvements in the allocate efficiency of the firm in focusing its resources on the more profitable products.

Price Recovery Ratio (market price & inflation rates)

It measures how effective the company is in maximizing output prices while minimizing input prices.

Cost & Profitability:Contribution Margin View (Driver-Based)

CFOs QUESTIONS CAN BE ANSWERED FROM A REVENUE/EXPENSE COMPONENT 23

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Phase II - Integrating Driver Base Contribution Margin with ROIC

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ROIC or EVA : Manage Capital by Department & Patient

Building Ambulances, etc

Fixtures, Beds, EtcX-ray & ComputerEquipment

Fixed Cost &Tax (to arrive atNOPAT)

ROIC per Hospital Bed = NOPAT / Allocated Capital

Hospital Bed Categories – Insurance Type, Age, Medical Purpose, etc

Primary – DepartmentSecondary - Patient

NOPAT

Step 2: Linear-Based ROIC

CapitalFrom

Systems * see key

Key : By creating the link between contribution margin and Capital at a detail level, you can look for the unprofitable customers, lanes, geographical areas

Driver-Based Contribution

MarginROIC and/or EVA

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Fixed Cost / Tax

Cost & Profitability: ROIC View

CFOs QUESTIONS ANSWERED FASTER WITH CONTRIBUTION MARGIN LINKED TO ROIC SEAMLESSLY

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Phase III - Integrating Planning and/or Rolling Forecast

Marketing:

1) Units

2) Revenue

Expenses =

1 ) Rate per key driver (See next page)

Driver Base

Contribution

Plan

Reconcile to

Finance

Plan

Create Trend Reports/Waterfall

Driver-Based Plan (Using Historical Actuals)

Analysis :

Validate correlation of Key Driver to Expense

Calculate ROIC

Plan (optional)

Moving Beyond Actuals: Calculating the Contribution “Plan”

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Phase IV - Integrating Advanced Analytics

Cost & Profitability Model:Optimize Your Business Process

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• Is your data fragmented or centralized?

• Are you trying to normalize the metrics of the company?

• Are you capturing “unique” data and using it?

• What focus is there among leaders on analytics?

• Is the analytics captured in the EPM framework?

• Is the analytics aligned with strategy?

• Are you trying to keep analytical talent?

• Are you doing any type of predictive analytics with what you have learned?

Is Your Company Doing Advanced Analytics?

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Architecture and Key Technology (OLAP)

• Phase I – Application to Report/Compare Actuals:• Waterfall Reports & Heat maps• Monthly Summary Profitability Letters• Customer Profitability

• Phase II – Contribution Plan/Forecast

• Phase III – ROIC reporting and forecasting

• Phase Iv – • Predictive Analytics & Exception Reporting• What-if Modeling & Business Optimization

• Phase V – Integrate Driver Based Forecast with Financial Plan

Key Phases: An Iterative Build Approach

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How it All Works

ERP

Flat Files

Cost & Profitability Model

Hyperion DRMOperational Data Stores

Financial Level

Hyperion Financial Management or

IBM Cognos Controller (Lean

Accounting)

Hyperion Planning or IBM Cognos

TM1(Driver Based

Forecast)

HSF(Strategy : Real Time, Realistic

what-ifs)

Key Component (OLAP): Oracle Essbase or IBM Cognos

Data Cube Importance – Slice and Dice helps with the following advanced analytics:

1) Descriptive Modeling and then2) Predictive Modeling which leads to

3) Optimization of Business Process Management 36

Olap is a springboard for moving from Reporting to Advance Analytics

Data Cube Importance – Slice and Dice helps with the following advanced analytics:

1) Descriptive Modeling and then2) Predictive Modeling which leads to

3) Optimization of Business Process Management

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Point of view for Deep Analytics

• Time (Mth, year, Week, Date)• Customer

• Region• Segment

• Route/Lane• Car Type

• Alternative View• Attributes (Optional)

Key Component (OLAP): Oracle Essbase or IBM Cognos

Key Reports

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Heat Maps

Waterfalls

Monthly letters, books

and web views

Mobile (real time)

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Conclusion and Q&A

• Powerful, fully integrated, fully extensible BI platform• Foundation for company wide BPM Frame work • Collaborative, familiar, user-centric tools• Cost effective, comprehensive solutions• Operating margins are linked to ROIC at a level you can manage

Improving your company by providing business insights to all your decision makers which leads to better, faster, more relevant decisions

BI Vision for a Cost & Profitability Driver-Based Model

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Our Speaker

Curtis MahanaySenior Functional ConsultantPerficient• 20+ years in the Hyperion BI and EPM space and application development expertise• Deep expertise in the process analysis, design and implementation of enterprise-scale

Hyperion applications around finance, operations including cost & profitability• Deep understanding for the need to link the enterprise to enable performance

management to become a reality• Certifications

– CPA (State of Texas)– AICPA Certified Information Technology Professional

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Contact: Curtis.Mahanay@perficient.com

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