FP&A Innovation, Spring 2014

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Sustainability Reporting

We look at how you can use sustainability to improve your finance departments

Forecast Accuracy

An exploration of how the telecoms sector are improving their forecast accuracy

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Editor’s Letter

Letter From The Editor Welcome to this issue of FP&A Innovation.

The aim of this magazine is to spread new ideas and insights into this vital business function. As we are seeing an increase in the amount of data that FP&A professionals can draw on and improvements in technology every day, this kind of publication is going to be vital to keep up-to-date with all of the latest issues.

In this edition we explore how Shyam Desigan, CFO at the AAPA, views the qualities that make a good CFO and how technology can play a part.

We examine whether crowdsourcing can be used for investments beyond startups and creative projects.

Emma Flanagan looks at how the telecoms industry is improving it’s forecast accuracy by using new technology and techniques.

We look at how sustainability reporting is worth far more to a company than a simple PR exercise.

Art Lorenz describes how he has managed to implement new FP&A practices at a highly decentralised company, Hunter Douglas.

How important is model governance? Moez Hababou believes that it should have more prominence in the minds of FP&A professionals. .

As always, if you have anything to say about the magazine or if you want to contribute, please contact me at ghill@theiegroup.com

George Hill Managing Editor If you are looking to put your products in front of key decision makers, Contact Hannah at hsturgess@theiegroup.com for more details.

Managing Editor George Hill President Josie King Art Director Gavin Bailey Assistant Editor Natasha Eves Simon Barton Advertising Hannah Sturgess Contributors Art Lorenz Emma Flanagan Moez Hababou Daniel Miller All Enquiries ghill@theiegroup.com

Contents

Contents

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Emma Flanagan examines how the Telecoms industry is using data to improve forecast accuracy We look at whether crowdsourcing is currently a viable option for funding projects beyond startups We look at how sustainability reporting is more than just a PR move and how it can improve your bottom line Art Lorenz, Head of FP&A at Hunter Douglas, discusses the difficulties of FP&A at a highly decentralized company Moez Hababou argues that we should care more about our model governance Daniel Miller, talks to Shyam Desigan, CFO at the American Academy of Physicians Assistants, about adopting new technology as a CFO

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Forecast Accuracy

Beyond Forecast Accuracy: Managing Scenarios in the Telecoms sector Emma Flanagan FP&A Leader

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Forecast Accuracy

The spotlight was on the telecommunications industry in 2013, with revenues reaching new heights and investments soaring. Alcatel-Lucent where part of this boom, they design and develop telecommunication infrastructures that allow for effective communications around the globe. At a recent summit, Jean-Philippe Gauvrit, CFO at Alcatel-Lucent, discussed their attempts to improve their forecasting and planning.

tion, but ultimately one that has FP&A at the heart of it. The overarching plan is three-years in length, but every year they build scenarios in which they detail the implications for specific geographical areas and products.

In essence, the “shift plan”, works on a best, mid, and worst case scenario basis, with the premise that, regardless of the situation, a strategy could be implemented that best suits the situation the business finds itself in.

Technology plays an essential role in Alcatel-Lucent’s ability to plan and forecast. Product life cycles have been cut extensively meaning that new technologies only remain current for a matter of months. The planning minefield doesn’t stop there. The industry is inundated with competitors and global markets are growing exponentially. For Alcatel-Lucent, all roads lead to Rome, keep up with the rapid nature of technological development, or risk being left behind.

The forecast plan takes shape after the planning process has been completed. There is a real emphasis placed on using the insights gained from the forecast to derive both organisational risk and opportunity. It’s a monthly process that looks at both Financial and Operational KPI’s.

At the

Financial

Forecasting

& Planning Summit, Shanghai in 2013 Alcatel-Lucent’s discussed their new “shift plan” . They want to refocus activities and align their operational, selling and management models.

It’s a heavy process that involves every element of the organisa-

Regardless of how innovative your forecasting and planning is, it’s the accuracy of your data that will allow you to leverage competitive advantages. Alcatel-Lucent understand that inaccurate data is important to avoid, but at the same time, they pose the question; is accuracy enough to secure the long-term profitability of a company?

When faced with bad forecasting, JP Gauvit used modelling to make new predictions as to the

Forecast Accuracy

expected outcomes of a number The aforementioned process heavily involves the sales departof his projects.

In 2012 Alcatel-Lucent had a ment and other business lines. very aggressive market plan due Importantly, this leads to the to the fact that they were invest- FP&A function becoming centraling in new markets. By the time ised. As a centralised function, March rolled around, it was clear there is a focus on value added that previous forecasts were not activities, including both Scenario planning and modelling. going to be accurate.

JP Gauvit knew that he had to show this in a clear and succinct manner to his superiors. Gauvit and his team looked to statistical modelling as a way of repeating the forecasting process to set more achievable objectives. By using historical data in the form of order intakes and sales from previous projects, Gauvit and his team simulated a new forecast that proved that the targets that had previously been set were no longer achievable.

By using a combination of historical data and insights from involved departments, JP Gauvit and his team came up with three scenarios that could potentially unfold and detailed what would need to be done, in order to create the best-case scenario.

FP&A functions have to identify the right scenarios for their organisations so that they can set achievable and adaptable targets. Having just embarked on a new project in Tunisia to extend ultra-broadband services throughout the country, Alcatel-Lucent will have to make sure their forecasting is as efficient as possible, as an array of potential pitfalls could occur.

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Crowdsourcing

Crowdsourcing: An Investment Alternative for Businesses?

George Hill Managing Editor

Crowdsourcing

Crowdsourcing as a platform for societal change is a new method for bringing about good. As finance professionals, its natural to wonder if a similar trend could be used within our remit.

The rise of crowdfunding platforms marks finances first steps into this area.

part in a company’s fortunes.

This is where an amendments to the JOBS Act comes in, Although title III of the JOBS Act is yet to be implemented, its underlining principals are likely to be of great interest to financial professionals. If set in stone, there will be no restrictions as There have been success stories to who will be able to invest on that certainly reinforce crowd- crowdfunding platforms. funding’s status as an invest- In principal this is a development ment alternative. that should fill businesses, and start-ups in particular, with optimism, as there are never too many investors. However, Title III also stipulates that companies taking part in this work must disclose certain financial and corporate information that could potentially damage their business strategies. As an investment alternative it’s not without its additional costs. If a company wants more than $500,000, lawyers and accountants will Up until now, this has been just be required, as will an extensive one of a number of cases that audit. have highlighted the advantag- Kickstarter is an interesting es of crowdfunding. Despite this, company and one that deals in Financial Professionals should “donations” rather than “investstill endeavour to approach such ments”. In return for a donation, success stories with a degree of donors receive gifts, which are suspicion. The JOBS Act states often in the form of first opthat crowdfunding platforms, tion on a product or a certain such as CircleUp, can only work amount when they are released. with investors who are worth Title III is in direct response to over $1million. A development the emergence of crowdfundthat puts a significant dampen- ing platforms that seek inveser on the perceived notion that tors instead of donors. Donor’s anybody, regardless of their fi- risk very little, and in return get nancial background can play a rather paltry rewards, whereas Take Eighteen-Rabbits, a San Francisco based Retail Company that specialises in organic granola bars. It turned to crowdfunding, more specifically CircleUp, when it needed to raise enough capital to expand upon the production of its “bunny bars”. They managed to raise $500,000, a sum they could never have imagined receiving from more traditional sources of investment.

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Crowdsourcing

investors might be persuaded to invest far more than they can afford, meaning that the states for them are unquestionably higher. Despite permitting crowdfunding platforms to accept self-certified individuals, Title III of the Jobs Act does state that an investor cannot invest more that 5% of their income on potential projects.

There are clearly a number of pitfalls with crowdfunding, which means that its status as a viable investment alternative is still very much up for debate. However, this hasn’t stopped a handful of platforms attempting to evolve in line with Title III of the Jobs Act. “Alphaworks” promise prospective investors “equity gifts” that basically

interest into the sustained development of your company.

For larger organisations, many of whom can guarantee bank loans, crowdfunding must be It’s certainly an interesting treated as a secondary form to time for businesses that are more traditional approaches. looking for new investment The news of Kickstarter’s avenues. The worry is that recent hacking may also put some will view crowdfunding off larger corporations who as an opportunity to exploit are considering crowdfunding certain sections of society as an avenue for investment. that don’t have the means to Only time will tell if Title III contribute to the success of acts as a catalyst to the a company as an individual. crowdfunding revolution or in In truth, it probably depends turn an inhibitor. on your company’s position in terms of maturity and economic power. equate to actual business ownership. These so called “gifts” will be available to both accredited and non-accredited individuals.

For smaller businesses, crowdfunding can be a more flexible approach that will see investors taking an active

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Sustainability Reporting

Sustainability Reporting the Key for Companies Looking To Implement Ethical Strategies Simon Barton Assistant Editor

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Sustainability Reporting

Being ethical, or appearing to be ethical, is an imperative cog in corporate strategy. Sustainability reports depicts a company’s commitment to ethical behaviour by measuring the effects of its output on the environment.

Even in the U.S., where Chief Financial Officers have always been unconvinced as to the value of the sustainability reports, investors are increasingly putting the heat on them to incorporate it into company strategy.

UN PRI reiterate that by adhering to their principals, a sustainable global financial system can be created that maximises the future profits and endeavours of participating companies and perhaps more e s sentially diminishes the chance of a future financial crisis.

The adoption of sustainability reporting is now widespread, with sustainability disclosure not an initiative solely for the exceptionally green. Ninety-five per- cent of Global 250 companies publish sustainability reports, outlining their commitment to improving operational performance through ethical strategies, designed to protect their reputaIn today’s business climate a tional assets. company needs approval from It’s impossible to get away with it’s stakeholders to operate efbeing unethical now. Consum- fectively and profitably. This ers are fully aware that the mar- necessary green light has been ket-based economy that many referred to as a ‘social license’, thrive in leads to a number of wherein an organisations ability social inequalities. Born out of to develop is based upon their this awareness, initiatives such acceptability and adherence to as the UN PRI, which sets a glob- ethical principals. The ability for al benchmark for organisations a stakeholder to bear witness to looking to invest responsibly has the endeavours of a company is been established. It sets six prin- far easier nowadays. Organisacipals that revolve around ESG tions are far more transparent, (Environmental, Social and Gov- and whether they like it or not, ernance) and their implementa- there is a vast amount of tion into financial strategy. The

Sustainability Reporting

information in regard to their strategy, financial performance and social responsibility online.

It is due to this that sustainability reporting, in some form, is widespread. 499 companies in the S+P 500 integrated some sort of sustainability disclosure, although according to an IRRC survey, only 1.4% have fully integrated it. Thus, it transpires that although implementation is widespread, going forward, the majority of companies need to include more information in order to improve their social sustainability. Non-compliance brings a plethora of risks linked with negative brand reputation and employee demotivation.

There is significant proof backing up this hypothesis. In 2013, The Boston College Centre for Corporate Citizenship and EY survey acknowledged that 50% of participants issuing sustainability reports saw an improvement in their company’s reputation.

Improved company reputation means increasing profits. The Innovation Bottom Line Report in 2012, stipulated that 37% of companies reported profits from their sustainability efforts, which was up by 7% in 2011. Perhaps fuelled by this development, 48% of companies included in the aforementioned report, developed their business models to adhere to sustainability opportunities. Interestingly, organizations in developing countries are more willing to change their

business models, perhaps down to the fact that issues such as resource scarcity can directly affect their operations.

The advantages of being ethical do not stop at profitability and company reputation, as the implementation of the sustainability report can have a positive effect on internal stakeholders.

Employees are likely to feel more loyal to a company if they are being viewed as an important cog in its future.

Employee retention was the m o s t prevalent trend with the S+P 500 companies. Other issues such as Climate Change and the reduction of Hazardous Waste were also deemed important environmental factors for companies.

Climate change is an issue that companies have to approach head on, as it continues to play an important role in the public psyche and the

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Sustainability Reporting

implementation of a sustainability report can go some way to quelling this fear. For example, the Global 500 report analyses how key sectors are addressing climate change. 80% of the Global 500 responded to the questionnaire, and by aggregating that data, it’s now apparent that; higher emissions are closely linked to rapid company growth and that financial incentives for employees, particularly at the board level, drive down emissions. By having an understanding of such notions, companies can implement best practices, designed at taking a holistic view of their operations, so that issues such as climate change are not directly effected by their outputs.

It is clear that Sustainability reporting can be a profitable endeavour for major companies. If the implementation of sustainability reports allow for numerous advantages, then surely we will see reports becoming standardized by every company who wants to work in an ethical manner. Some of the worlds largest companies have complied, HSBC, Ernst +Young and PWC all publish sustainability reports and are active in their mission to help create a sustainable global economy. Outside of climate change, other issues remain of

upmost importance, including; the scarcity of natural resources, poverty, human health and clean water consumption. Companies lacking one will ultimately run the risk of their operations being heavily scrutinised and deemed unethical, a situation that is catastrophic in today’s business climate.

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Do You Have The Spark?

If you have a new idea that you want to tell the world, contact us to contribute an article or idea ghill@theiegroup.com

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Art Lorenz

FP&A at a Highly Decentralized Company Art Lorenz Head of FP&A, Hunter Douglas

Art Lorenz

Hunter Douglas is a highly decentralized organization running on multiple ERP platforms. This complicated the situation when we needed to replace our Cognos Finance software. Hunter Douglas had been running Cognos Finance since 1998 (it was originally purchased as Lex 2000), which was a good tool for consolidations and management reporting, but IBM was phasing it out so the company felt a change was necessary.

budgeting and planning. The long term objective is to have all of our divisions on BPC for budgeting and planning as this would provide greater consistency and more detail with less effort both at the corporate and divisional level. Importantly, we will need to educate the divisions on the benefits of BPC and how it could help their processes.

To support current users and to help with the integration within new divisions, this year we We would have liked to mandate are planning to establish a BPC one consolidation and planning portal for internal users. The system throughout the compa- portal will be the place to share ny, but being highly decentral- best practices and discuss ideized this was not an option. We as amongst our internal comdecided to start with a limited munity. Not only would it be a rollout and selected SAP’s BPC central hub for questions, but it (Business Planning and Con- could also act as a repository for solidations) as the software. In knowledge, with training videos 2012, we implemented SAP’s and other documentation freely BPC in four key areas; consol- available. We are also workidations at Corporate, sales ing on establishing internal planning in distribution, finan- and external BPC user cial planning in manufacturing, groups so that we can budgeting and forecasting for share what we have learned and additionthe corporate departments ally, learn from others Now that we have BPC both within Hunter installed we Douglas and would like to outside. roll it out to additional locations f o r

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Art Lorenz

There is an opportunity to move beyond traditional management reporting with the new cloud based software on the market today. Current management reporting is somewhat stagnant and the reporting concepts are generated from a limited number of users. Fortunately, modern software provides options for a more dynamic interaction; it’s like social media meets analytics and crowd sourcing takes on report building. There is the ability to have real time multiple user discussions with the program. At the same time, unlimited users can change the reports based on their views and their needs. All of this is done while everyone is viewing and using the same data, eliminating the ‘whose data is correct?’ discussion.

In the past, I had the ability to create a model which was fairly accurate at projecting sales trends 11 months in the future.

The model was based on one economic indicator and took a tremendous amount of time to create. When the financial crisis came it changed the pattern of the economic indicator I was using and consequently made the model obsolete. The software we are looking into now has over 250 indicators that can be correlated to our data. The objective would be to use multiple highly correlated indicators to help forecast sales trends 1218 months in the future. Also, my original model looked at total

US sales. The objective with any new software would also be to forecast sales trends at a much lower level, as narrow as state or possibly even zip code level.

Another option we are investigating is the use of Google Trends. This could potentially help us to forecast more immediate sales trends.

With the options available today, FP&A needs to continue to not only focus on its core functions but also needs to become a facilitator to help users collaborate on analysis and reporting in order to take advantage of the power of crowd.

All the while exploring new options that could benefit the organization.

Model Governance

Why Should We Care About Model Governance?

Moez Hababou, Ph.D, Director, Risk and Business Analytics, UBS

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Model Governance

“With great power comes great responsibility�. This line from Spider Man illustrates the increased importance of predictive analytics in shaping and driving business decisions, and the perils associated with misusing these powers. Recent history gives us several examples where inadequate controls resulted in disastrous outcomes. The financial crisis that shook the world and caused a global recession in 2008 was partly caused by incorrect financial models which continued to predict increase in the real estate market. The Challenger shuttle disaster in 1986 was in great part due to NASA's organizational culture and decision-making processes that put too much emphasis on reaching success and overlooking risk without the proper controls. In 1995, a basic model error (a missing minus sign) caused Fidelity’s Magellan Fund to overstate projected earnings by $2.6 billion and miss a promised dividend.

With cheaper disk space and expanding data availability, analytics took a center stage in driving critical business decisions and strategies. However, with the proliferation of models and analytical tools, it has become imperative to put in place the proper controls to avoid the misuse of models so that they are still fit for purpose. Since the financial crisis is 2008, regulators have stepped up their su-

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pervision of models and stated that "Model risk should be managed like other types of risk: Banks should identify the sources of that risk, assess its magnitude, and establish a framework for managing the risk ". Consequently, it is the responsibility of financial institutions to "ensure that their model risk management policies, procedures, and practices are consistent with this supervisory guidance. " Increased and tighter controls need to be designed and implemented around how models are developed, implemented, used, and monitored, as shown in Figure 1. This means that model validation is no longer restricted to basic tasks such as back-testing the model on a periodic basis but now extends to all phases of a model lifecycle.

Figure 1: Model Validation Stages

MODEL ORGANISATION

PERFORMANCE REVIEW

MODEL DESIGN

MODEL VALIDATION

USE IN PRODUCTION

IMPLEMENTATION

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Model Governance

at the highest level and cover the full model development lifecycle (conception, design, development, deployment, monitoring, recalibration, and finally retirement). These policies need to identify what constitutes a model and which analytical applications should be covered under its program. It should also spell documentation and approval needs out for all models prior to any use in production.

In figure 2, inspired by the 2005 FDIC guidelines on model governance, I identify four major components to model governance: A. Policies and procedures providing oversight throughout the organization commensurate with overall reliance on models.

For a model governance program to be successful, it is important to have buy-in and support from Senior Management.

Thus, the Model Governance Committee should be fully empowered and have a cross-disciplinary senior representation from the C-level offices including Risk, Marketing, Technology, and Credit. The model governance policies should be ratified

B. Adequate controls to review and approve model development and validation work prior to deployment and use by the business. These controls depend on the criticality and complexity of the model. There should also be easily retrievable logs documenting the various milestones and approvals during the model lifecycle. For independent reviewers, controls should identify the validation elements for new models. The OCC Risk bulletin 2000-16 identifies the following validation items: i.

Data: is the raw data used clean, fit for purpose, and is the history being used representative of the population we would be scoring at deployment? ii.

Assumptions: are the behavioral assumptions used in the model comparable to actual portfolio behaviors? iii.

Theory: is the theory used by the bank sound? iv.

Code and Mathematics: Is

Model Governance

the methodology and predictive technique used appropriate? Has the model been deployed correctly? Were there any coding errors in the implementation?

sights on whether the models are still fit for business use.

Alternatively, we may have to re-calibrate, retire, or rebuild some or all of the model segments.

i.

Discriminatory power or lift; that is how well the model differentiates between good and bad customers. Typically this is measured by the Gini or KS statistics in case of binary outcomes and R-squared or rank correlation in the case of continuous outcomes ;

governance and controls are equally important to non-regulated companies because they: • Significantly reduce model risk.

• Ensure consistent and scalable model development and increase the efficiency and consistency of the analytical work. Hence, models will be of better quality and will have a longer shelf life.

• Reduce development and design errors through the peer review and approval process and ensures that the analytical tools used by the business are not flawed.

• Produce better knowledge transfer and protects companies from the loss of intellectual capital in case of staff attrition.

• The final scenario is especially important for analyt-

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ical vendors targeting highly regulated clients. These clients may prefer or require analytics providers who can demonstrate strong governance and robust modeling C. Periodically validate D. Finally, when required, processes. and back test to determine there should be an internal In conclusion, model governwhether models are working audit team, which verifies ance reduces model risk and as intended. Model develop- compliance with established makes business sense. ment staff or external parties model validation policies and with appropriate independ- procedures. ence and expertise should Now, some skeptics may say conduct the back testing. The "my industry/area is not regback testing typically covers ulated, why I should care?" In three aspects: my opinion, adequate model

ii. Predictive accuracy; that is how accurate is the model in predicting the 'event rate'. iii.

Score distribution; here examine whether there is any sort of population shift, and if the through-the-door population has the same characteristics as population development.

Back-testing should be done for each modeling segment.

We can then draw a model back-testing dashboard which provides empirical in-

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The Successful CFO

Shyam Desigan: The Successful CFO Daniel Miller FP&A Leader

The Successful CFO

Frost and Sullivan, the research firm, anticipate that the use of analytics within hospitals will increase by 50% by 2016. Combined with the implementation of the Affordable Care Act on Jan 1, significant pressures are mounting on FP&A departments, meaning that clear challenges lie ahead for those working in healthcare FP&A teams.

This is an issue that Shyam Desigan, CFO at the American Academy of Physician Assistants, is currently working with. He has worked across a number of different industries, for both for-profit and not-forprofit organizations and has a plethora of experience as a Chief Finance Officer.

Throughout his career, Shyam has always been interested in new technologies and innovations that have the capacity to improve financial strategy. So I was curious to hear his opinion on Bitcoin.

Digital Currencies have been the subject of considerable media attention recently, with a number of companies starting to accept them as currency. Shyam

emphasises the importance of planning and thinking ahead, his thoughts are, therefore, focused on research and monitoring, instead of diving in at the deep end. He sets a timeframe of five years for its successful implementation, due to the difficulty of managing the growth of the product.

Shyam knows that Bitcoin is an important tool and that CFO’s have to be

ready for its imminent arrival into the mainstream, but he is wary of its use at the moment. He states; “Their value has fluctuated a lot. Financial Markets like to see a more stable currency than Bitcoin” confirming his assertion that Bitcoin is one for the future rather than the present. Despite the hype, this seems a sensible standpoint considering Bitcoin’s puzzling tax status and its links to the dubious black market trading site SilkRoad.

The ability to plan for future developments like Bitcoin is just one of the attributes needed to be a successful CFO. Fortunately, Shyam is well versed on the requirements of a CFO, having operated in the position for the

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The Successful CFO

last ten-years. He is quick to assert that the role of the CFO has adapted. “The CFO should be a partner to the CEO, so we can shape the organisation together”. Vigilance as to the development of new trends is irrefutably essential, and something that Desigan has always kept to.

He outsourced content designs for the AAPA and shifted content from print to digital, saving the organisation $400,000. He states “Technology can have a drastic impact on the business model”. The modern day CFO has to work closely with the CEO so that they can make strategic decisions that mould the business model and correctly align the organisation.

Shyam is an advocate of streamlining financial reporting as due to the improvement in the time it takes to close their books. Companies can speed up the decision making process, so that more time is available for other important activities.

Shyam agrees that streamlining the financial process is an important issue.

He emphasises that “it is not just about creating the financial report but having a discussion

and analysis around it, we need to look beyond tables in order to make the company story more interesting”. He believes that standardised operational metrics have to be expanded on, so that the financial report incorporates more elements.

Desigan believes it is a necessity to look at ‘the big picture’ and conveying the story of the company. This needs communication, both internally and externally with stakeholders so that they understand why certain metrics are impacting the company’s financial position. Above all, Desigan points to the importance of involving as many metrics into the financial report as possible.

Desigan has a firm grasp of some of the most important issues encompassing the future of finance departments and CFOs. He is clearly always looking at new ways to improve processes and this regardless of what business function you are in, this trait is vital to anybody looking to succeed in business.

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