Business Agility transformation is a challenging undertaking. As business has evolved, we have developed agile methods to optimize operations, convert monolithic project management into a constant flow of value, and change business culture for the betterment of all. The slowest evolving piece, however, has been financial business management. In this post, we examine the current state of finance, business accounting and how financial agility enables business agility as a whole.
Business at its core is the exchange of value from one person to another. This exchange of value has evolved. There was the exchange of sustenance for protection and survival. Then, the trading of goods in ports across the globe. In today’s modern world, the most common exchange is currency – a unit of stored value – for products and services.
Likewise, accounting has evolved. Today’s practice of budgeting for business expenses is typically classified in terms of capital and operating expenditure. Most companies working with a hierarchical organizational structure are also commonly divided into two opposing ways: profit centers and cost centers.
Profit centers are departments or divisions within a company – usually the sales team – that can directly attribute their contribution to its bottom line. Meanwhile, cost centers are the units that operate on cost alone, both supporting the profit centers and requiring the profit centers to fund them. These departments are usually everyone else, including marketing, operations, accounting, finance, professional services, customer service, information technology, research, and product development.
The division between profit centers and cost centers has created a tense dynamic that warps many companies’ culture. Cost center leaders find themselves frequently struggling, pleading to purchase new equipment or hire additional team members to keep up with the business. Profit center leaders find considerably less resistance. The reason for this is simple: cost centers, by definition, cannot show how investments in their teams improve that bottom line, while profit centers can. Members of cost center teams see this very visibly. The effects are destructive to a positive culture, leading to frustration, low morale, and often an “I’m just in it for the paycheck” attitude.
Dividing between profit centers and cost centers has another significant fundamental flaw. This profit/cost center split causes companies to become vulnerable to change from the outside. Reacting to moves from a competitor or a change in customer demand results in a drawn-out exercise in project cost analysis, reactive re-budgeting, organizational restructuring, and political negotiation to shore up weak cost centers in response to change.
“One of the biggest mistakes I have made during my career was coining the term profit center, around 1945. The truth is that inside the business, there are only cost centers. The only profit center is a customer whose check hasn’t bounced.”Peter Drucker, Managing in the Next Society, 2002
What is Financial Agility?
Financial Agility is the ability of a company to structure and fund business activities in a manner that allows them to respond to change and disruption quickly while fostering an agile business culture. Financially agile businesses can adapt investment focus, resource allocation, and initiative funding dynamically instead of the practice of static yearly budget planning.
The foundation of Financial Agility is based on three concepts:
Fund Value Streams, Not Profit Centers or Cost Centers
A value stream is the sequence of actions a business uses to create an uninterrupted flow of value to a customer. Your business may sell a software product, a computer hardware product, an implementation service, and a technical support subscription. Each one of these is a value stream, where a customer becomes aware of the product (marketing), learns if the product is a fit (sales), purchases the product (finance), receives the product (fulfillment), and gives feedback on improvements (support). The product has to be designed (product management), built (development), and maintained (operations). All of these require systems (information technology), processes (project management), automation, and data (revenue operations). Agile businesses don’t fund portions of it based on revenue or expense. They support the entire stream and use data from the whole stream to make funding decisions moving forward.
Investment Around the Value Stream Lifecycle
Value Streams, for the most part, don’t live forever. Value Streams have a predictable lifecycle: concept, startup, growth, and retirement. Value Streams require different solutions – systems, processes, tools – at each lifecycle stage to keep customers’ value flowing. These solutions need adequate investment to sustain and grow the Value Streams they support. Investment in financially agile companies requires balance and fluidity in planning for each lifecycle stage.
Rules-Based Budget Allocation
In simple terms, traditional budgeting allocates funds for each cost center and profit center by coming up with a revenue goal, considering initiatives for investment, looking at last year’s expenses, and adjusting for the upcoming year. It’s a predictive process that causes mid-year adjustments to be mired in the financial equivalent of juggling.
Financially agile companies allocate funds to Value Streams fluidly based on lifecycle, capacity needs, and strategic initiatives chosen for investment. For example, the reallocation of budget funds from a Value Stream near retirement to an emerging Value Stream or moving investment to a Value Stream that now has a higher priority due to a change in strategy. Regular involvement of business owners and executives ensures that budget and resource allocation can be adapted swiftly due to changes to company strategy, customer demand, and the external business environment without a tedious budget-balancing undertaking.
Agile requires more than just a transformation of project management and operations practices. A successful transformation into business agility requires a holistic approach to all aspects of a business. Financial agility transformation removes the budgeting bottleneck that slows down the pace of business and improves a company’s ability to react to opportunities and threats in the business landscape.