Profit Driver: The missing link

Observation #1

carpedia-observation-1In many organizations the link between the financial and operating world is missing. Financial results can’t be managed on a daily basis, but the activities that create them need to be.

It’s often very hard for managers and employees to know how the activities they are performing today are actually affecting the financial results of the company. Sometimes it’s because activities that are being performed today are being done for a future benefit, like sales meetings trying to progress a sale, or building parts destined for some downstream assembly operation. The missing links in these two examples might be not knowing how many sales meetings are needed to generate enough revenue in the future, or how efficiently parts need to be produced to eventually achieve the planned operating margins.

Accounting systems tend to be historical records of what happened and less what needs to happen to achieve a result. The information is often aggregated too late to be overly useful for front-line managers. The tool organizations try to use to align the financial and operating worlds is the budget. Unfortunately budgets summarize operational outcomes, which is helpful to set financial targets but not overly helpful for identifying the underlying “activity drivers”. For example, budgets identify sales by region or market, but not the number of new prospects required to eventually create those sales.

Converting outcomes to the actual activities that create them is critical to providing managers with the tools they need to properly manage an area. These conversions (or assumptions) are built into every budget ever created, they are just not often explicitly identified. We call these missing links “profit drivers.” They are what managers actually manage on a day-to-day basis and when properly linked they align the financial and operating worlds.