Wednesday July 24, 2019

Finance Function Budget July 2019

The Standards of Excellence

Finance can bolster organisational performance by strengthening monitoring and forecasting, risk management and ensuring transparency and control. The success of such initiatives, however, depends on the CFO’s ability to create an efficient, high performing Finance organisation. Understanding best in class standards and knowing where one stands relative to peers is a crucial first step. While global benchmarks on Finance department performance exist, the Indian reality is less well-researched. This paper examines one aspect of Finance excellence: the cost of running the function. It draws insights from IMA India’s 2019 Finance Department Performance Benchmarks study as well as interviews with CFOs.

Size matters

Beyond a certain revenue threshold, there are economies of scale to be realised from running a finance department

IMA’s research shows that the most cost-effective organisations (those that spend at or below the 25th percentile in this performance range) spend 0.7% or less of revenue to run the Finance function. On the other hand, high spenders (75^th percentile or above) spend at least 2% of revenue to perform the same work. At the median, companies spend 1.1% of revenue to run Finance. As organisations grow larger, the relative cost of finance as a percentage of revenue should decline. Our data shows that for this measure, size does indeed matter. The smallest (<Rs 100 crores) firms spend as much as 2-10% of revenue running the department, while the largest ones (>Rs 5,000 crores) spend below 0.5%.

Cost trend: upward pressure to continue

Upwards pressure on costs to continue

Interestingly, despite 59% of CFOs believing that their current budgets are ‘just right’, upward pressure on costs are likely to continue possibly accelerate, as Finance functions apply new automation technologies such as AI and RPA. Where savings have been made by adopting new technologies, there has been an offsetting drive to invest in people and the skills they need to harness the potential of technology. Resultantly, 43% of CFOs expect their Finance spends to rise by 10% or more in FY20.

Investments in people, skills, and technology and systems are key drivers of finance cost

The gap between the drivers of finance costs for top-quartile companies and those in the median range of performance remains high. For instance, technology and systems and finance staff headcount will individually drive a 10% increase in costs of a top quartile company but only 5% and 7% respectively in the case of a median firm. This is indicative of the fact that the challenges for the bottom quartile spenders i.e. the more efficient companies, are more difficult as they have already drawn upon traditional routes to economise, such as process standardisation, shared services and automation. Hence, further efforts entail higher incremental costs than for a company that is younger in its efficiency journey.

Cost variations across industries: wide

Wide cost variations exist across industries

As may be expected, the Finance function cost varies by industry. Sectors such as Consumer Goods tend to have lower costs of Finance due to the intense focus on cost control and margins, process efficiency and relatively mature business models. Pharma and BFSI, on the other hand, generally have higher costs, driven in part by heavy regulatory burdens and complex business models.

Where does the money go?

Transaction processing and treasury are the two biggest areas of spends

Typically, the two biggest areas of spend are transactions processing (25% of the total) and treasury (13%). Investor relations, business partnering, employee claims processing and tax make up for another 37% of the total budgetary spends. Smaller organisations (< Rs 100 crores) in the services sector spend almost three times as much on payroll compared to their manufacturing counterparts. Large services organisations (>Rs 5,000 crores) spend a fifth of the total on business partnering. In general, leading organisations seek to free up resources from routine activities for investment in higher-quality business partnering and value-adding activities.

Indian-owned companies spend relatively more on transaction processing and employee claims processing, while foreign-owned ones spend more on tax and treasury. This is reflective of MNC systems that centre more on risk management and controls, as well as the complexities around international taxation for such firms.

People costs and professional services fees constitute over 70% of Finance budgets

On a line-item basis, the lion’s share (56% on average) of most Finance budgets goes towards personnel costs, while another 16% is allocated to professional service fees. The percentage spends on travel and entertainment is roughly equal to that on staff training and development. Ownership also influences spend. For instance, companies that are listed overseas allocate more than twice as much to professional services as do companies listed in India.

Leading organisations are harnessing technology and investing in people and skills

In sum, every organisation today wants to ‘transform’ Finance into an capable and lean function, one that enjoys economies of scale. Conventional measures such as process simplification, shared services and outsourcing have yielded improvements but leading companies have made further strides, by harnessing the potential of new-age technology and investing in people and skills. In the short run, this does drive costs up but in the long run, CFOs feel confident of realising lasting efficiencies in the Finance function.