There Is More to Business than Finance

October 2005

Finance is just one piece of the story of an organization’s success. Yes, I am an accountant and I actually wrote that sentence! If you really think about it, good financial standing is a result of doing many other things in the organization well. You can’t generate a profit over the long haul if you don’t have a good product or if you frustrate and drive off customers and employees.

All that financial analysis can do for you is to give you clues of something else happening—it might indicate that customers are being driven away—it won’t tell you what is driving them away. The financial statements won’t say customers are being driven away by a bad jingle for instance—all you will see is a decline in revenue over a period of years. When this happens, your next question is, “Why did revenues decline?” The financial results were a clue and now you are going to have to do a little snooping around, asking tough questions of managers, customers, and possibly even suppliers.

The Balanced Scorecard Gives Us a Broader Perspective

To get a broader sense of how successful and stable the company is, you may want to use the structure of the balanced scorecard model.

Robert Kaplan, a professor at Harvard University, invented the balanced scorecard model. He argues that businesses should create goals and metrics in four categories, not just one.

We are very good, after decades and decades of compiling financial information, at generating financial metrics. Most organizations have pretty good systems in place to gather, compile, and summarize financial information. And many times, unfortunately, it is the only set of metrics that organizations look at to determine if they are successful. In the balanced scorecard model, finance is just one of the four areas you analyze.

Kaplan’s balanced scorecard model includes four components:

1. Financial
2. Customer
3. Internal Business Processes
4. Learning and Growth

The balanced scorecard encourages managers to take a more holistic view of the organization. Oftentimes, when companies are in a financial crunch, they put a stop to any training or travel for the employees. While this results in better short-term financial results, it may have a negative long-term impact on the learning and growth area. It may even hurt customer relationships or allow internal business processes to deteriorate.

The balanced scorecard is just that, a scorecard—a report card, if you will—that looks at a balance of areas and metrics. Ideally, systems would be in place to compile and report on metrics in each of these four areas as often as possible. One organization I consult with calculates certain metrics daily. Others might report on the metrics monthly or quarterly.

The Financial Component

In Kaplan’s model, the financial component asks, “How do we look to our owners?” It asks, in essence, are the owners happy with the return they are getting on their investment in the organization?

I teach a course on financial statement analysis to CPAs and in it we cover more than 70 different metrics—a really long day to say the least! We have been generating these types of metrics for centuries and are quite good at it now. It is the most fully developed area of the balanced scorecard. It includes the financial metrics we discuss in the remaining chapters.

The Customer Component

The customer component asks, “How do customers see us?” Here we create goals and metrics to determine if we are going a good job pleasing our customers. We might ask, for instance, if our customers are loyal, repeat customers.

Many organizations already do a good job at collecting this sort of information. We have been concerned about customer satisfaction in this country for several decades now. Examples of metrics in this area include:

• Market share
• Customer acquisition
• Customer satisfaction
• Customer retention
• Shares of the customer wallet
• Response time
• Convenient access
• Brand recognition

The remaining two components are great to monitor but are sometimes hard to quantify. These are the least developed areas of the balanced scorecard. Many organizations ignore these aspects of a business’s success entirely.

Internal Business Processes Component

Internal business processes asks, “What must we excel at?” In other words, how do our internal systems need to function in order to have happy customers and good financial results?

For instance, I was working for a high-tech company that had doubled in size each of the previous five years. At the quarterly meeting, the CFO congratulated everyone on the growth of the organization but redirected everyone’s attention to the problems that would keep them from succeeding in the future.

He likened the company to a sleek rocket ship racing to the moon. From the outside, everything looks perfect. However, when you open the cockpit door, you see a little fire in the nose of the ship and thin, haggard, mice are running furiously trying to keep the rocket moving.

Yes, the company had grown, but the internal processes had broken down. The wrong products were being shipped to the customer, the quality of the products was slipping, and employees were not getting reimbursed for travel expenses for several months. He directed all managers to focus on cleaning up procedures and processes before chasing down additional market share and new products.

I once ordered all of my family’s Christmas presents from one fabulous-looking catalog. It was full of all sorts of fun outdoor items that I hadn’t seen anyplace else. The catalog company gladly took my money and promised delivery a week before Christmas. Finally, around Valentine’s Day, the gifts arrived. Great product, great marketing, horrible execution. I will never order from them again, no matter how tempting their products are.

Examples of metrics for this component include:

• Amount of research prepared on emerging and future customer preferences
• Percent of sales from new products
• New product introductions vs. planned
• Percent of defects
• Time customer must wait for delivery

Learning and Growth

This component of the balance scorecard asks “Can we continue to improve and create value?” Here we ask if we have the infrastructure, the people skills, and the information systems to get us where we want to be in the future. This section asks whether you are set up for success. Are you investing in the skills of your people and in technology to get you where you want to be?

Under traditional, short-term financial measures, it is not in a manager’s best interest to enhance the capabilities of subordinates, systems, or organizational processes. So sometimes this area is sacrificed in order to achieve short-term profit or cash flow.

For instance, a company may focus on profitability and cash flow to the detriment of long-term strategies. One organization I worked with decided to stop offering employees training sessions because they were trying to cut expenses. In cutting expenses, they also were cutting customer service because the employees weren’t being trained on how to handle customer complaints. Over time, the business lost several key customers and hence their revenue went down even further. What was their solution to this problem? Cut training even more to reduce expenses and make up for lost revenues… a nasty downward spiral, wouldn’t you say?

Possible Metrics

• Employee retention
• Competency upgrades of employees
• Percent of employees who have access to customer information
• Number of suggestions per employee
• Percent of employees whose professional goals align with organizational goals
• Percent of team-based-relationships with other business units

To learn more about the balanced scorecard, I suggest you go to the Harvard Business School web site and purchase some of Kaplan’s books or online courses. You could also come to my class in Denver on the topic—see courses at www.leitahart.com.