Businesses are constantly evolving and changing. Ensuring that a company is moving in its intended direction takes significant management and oversight. Financial performance management (FPM) is a proven way to keep tabs on financial results and discover opportunities to improve efficiency and profitability. FPM is a data-driven, objective approach to examining a company’s financial health that can be used by companies of all sizes and in all industries. Here’s how it works and the benefits that it can help businesses realize.
What Is Financial Performance Management (FPM)?
FPM is a time-tested, structured approach to monitoring, analyzing and tracking financial results toward a goal, a systematic process of financial analysis to support decision-making, using key performance indicators (KPIs), trend analysis, forecasting and other empirical data, mixed with business acumen and industry expertise. Performance management has always relied on practical business sense combined with data analysis. Today, supported by advanced information technology, FPM has become even more powerful and meaningful.
Key Takeaways
- FPM uses reporting, planning and analytics to examine a company’s financial health and uncover possibilities for improvement.
- It’s an ongoing process that relies on accounting data from the primary financial statements, along with operating data.
- Budgets, forecasts, KPIs, trend and variance analyses are some of the FPM tools for monitoring and measuring financial performance and supporting changes in operations.
- The right software enhances FPM accuracy and timeliness and helps business managers to redirect their efforts toward analyzing, interpreting and acting on data, rather than generating reports.
Financial Performance Management Explained
FPM can be described as a concentrated subset of business performance management (BPM). Whereas BPM is a set of tools to help a company track toward strategic goals across all its different functions, including finance, marketing, production processes and human resources, FPM focuses on financial health. FPM’s objective is to monitor, measure and improve financial results and financial processes. Though business leaders often view FPM-style analyses as tools to boost profitability by cutting cost from their operations, FPM can also identify opportunities to “lean into” business successes — in other words, to boost profitability by raising revenue.
How Does Financial Performance Management Work?
FPM uses reporting, planning and analytics to monitor results and support decision-making. Primarily, FPM information includes the primary financial statements — balance sheet, income statement and cash flow statement — and the accounting data that underlies them. In addition, operational data, budgets and forecasts round out the informational foundation for FPM work. The information is analyzed using selected KPIs, trend analysis and other metrics to examine a company’s efficiency, liquidity, valuation and profitability. Business acumen, industry expertise and a thorough understanding of company operations are also essential for effective FPM. That expertise guides accurate data interpretation and development of action plans based on the findings.
FPM is an ongoing process, with standardized financial reports that are published and updated regularly. Financial software enhances FPM by ensuring that its analyses are always based on the most current data and by making it more easily accessible via dashboards and real-time alerts.
Let’s take a closer look at the key aspects of FPM.
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Budgeting and Forecasting
A company’s budgets and forecasts play an important role in FPM, serving as benchmarks to gauge actual results. A company’s budget is the financial companion to its strategic plan; the budget sets goals for the year, shows targets and lays out planned resource allocations for reaching those targets and goals. Monitoring actual results as compared to budget is the essence of financial management: It helps to identify the areas that are — and are not — going according to plan. Forecasts, which estimate results using the most current internal and external factors, are another yardstick for comparison. Comparing actual results to forecasts identifies variances from expectations and helps to recast future forecasts, making them more accurate. With FPM practices, actual performance that deviates from either the budget or the forecast is investigated and adjustments to operations are made to close gaps or exploit opportunities.
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Financial Reporting
Financial reports are a primary source of information for internal management and for external stakeholders with an interest in a company’s performance, such as current and potential investors and lenders. In FPM, the three primary financial statements and other compliance reports are used to assess how a company is doing. External parties tend to rely on financial reporting because it is prepared in a standard, consistent manner in accordance with generally accepted accounting principles, or GAAP, in the U.S. or International Financial Reporting Standards for companies operating outside the U.S.
- Regulatory compliance: Financial reporting for regulatory compliance includes a company’s balance sheet, income statement, statement of cash flows and the notes to the financial statements. In addition, some companies prepare an annual report, and public companies file with the Securities and Exchange Commission (SEC) an annual Form 10-K and quarterly Form 10-Q. These documents are especially useful because they include comparisons to prior fiscal periods, as well as to current year-to-date information, which can highlight trends.
- Internal and external reporting: Internal reports and specialized external reports can also be useful for FPM because they are customized to address specific management concerns. For example, debt covenant reporting that is required for a particular lender contains information that can also be used in FPM to assess a company’s leverage-related performance, such as debt coverage. Or, company managers could glean valuable performance-related insights from a monthly internal report showing gross margin by product.
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Financial Analysis
Ratio analysis and trend analysis are two common types of financial analyses that are integral to FPM. Both involve capturing data and interpreting their results to evaluate performance. Financial analysis is most effective for improving a company’s financial performance when viewed over time or compared to external benchmarks, such as industry averages.
- Ratio analysis: Analysts use a long list of financial ratios and KPIs to evaluate performance. Ratios are especially useful because they show relationships between multiple financial data points. The accounts receivable turnover ratio, for instance, indicates how many times the credit sales and cash collection cycle is completed during a period of time. Financial ratios are categorized by the type of relationships they measure, such as efficiency, liquidity, profitability, leverage and company valuation.
- Trend analysis: Trend analysis can uncover historical patterns and plot the direction of a certain metric over time. This helps provide context for company performance. For example, a revenue trend analysis shows past sales levels and marks whether they have grown, contracted or remained constant over time, in addition to detailing seasonal fluctuations that companies can address. Sometimes, trend analysis reveals erratic movement, which is also helpful, especially for risk management planning.
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Profitability Analysis
This area of FPM focuses on how well a company generates profit. It involves analyzing both the revenue and expenses of the products and services a business offers. Various measures of profitability are analyzed in order to evaluate opportunities to improve profit margins at different stages of a business’s operational processes. Gross profit is the core profitability measure, since it represents the revenue left over after subtracting the direct costs to produce a product, called the cost of goods sold (COGS). Other measures of profitability, such as operating profit, EBITDA (or, earnings before interest, taxes and depreciation) and net profit, are expanded measures that include more types of revenue and more expenses. In many organizations, improving profitability is the primary goal of FPM.
- Cost management: One way to improve profitability is by reducing costs. That may sound simple, but cost management requires careful analysis. Identifying which costs can potentially be reduced without creating unintended declines in revenue demands a keen understanding of operations and customer value. Cost management is the investigation of opportunities to reduce both operating costs, such as sales, marketing and overhead, and COGS, including raw materials and direct labor costs.
- Revenue optimization: The other way to improve profitability is by raising revenue. This entails analyzing sales volume and selling prices. Different from simply maximizing revenue, FPM also looks to optimize it, which involves determining the most profitable mix of products (or services) and may lead to launching or discontinuing offerings.
Benefits of Financial Performance Management
Financial performance management yields several benefits in addition to its two primary objectives — improving a company’s performance and tracking progress toward a financial goal. Here are six additional advantages.
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Improved Decision-Making
The data-driven, unbiased nature of FPM analyses leads to improved decision-making, especially for leadership prone to decisions based only on gut instinct. To deliver this benefit, data needs to be timely and accurate. Furthermore, the analyses should be relevant to the task at hand, using carefully selected metrics and KPIs. For example, a business whose profits are declining due to rising raw materials costs might look at several different metrics, in multiple areas of the company, to attack the problem. Examining inventory turnover, sales trends and forecasts is helpful before shopping around for new suppliers and can lead to better contract negotiations. At the same time, accounts payable metrics, like the early payment discount capture rate, might also be examined to identify missed vendor discounts.
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Enhanced Profitability
Because ongoing vigilance is a key part of FPM, it positions a company to spot problems and adjust operations more quickly, leading to greater profitability. If a business is underperforming, the causes of its losses or anemic profitability can be swiftly addressed. On the other hand, if a business is overperforming, it may be appropriate to reallocate resources to fuel the opportunity. For example, if air fryers become a hot commodity, a maker of small appliances could exploit that opportunity by reallocating resources from other, less profitable areas in order to add new air fryer models and ramp up production.
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Better Forecasting and Planning
FPM makes forecasting and budgets more accurate by using trend analysis to identify patterns grounded in history that can be extrapolated into future periods. In addition, ongoing comparison to actual results improves the reliability of the estimates that are embedded in a company’s budgets and forecasts. FPM also saves time during the budget process because it does a lot of the preliminary work that goes into budgets and forecasts on an ongoing basis.
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Increased Efficiency
The more areas a company monitors and measures, the more opportunities it will unearth to reduce costs or increase output — the two ways to increase efficiency of production and processes. For example, keeping close tabs on the cost of raw materials can help spot opportunities to reduce costs, such as stocking up during periods when costs are low. FPM also helps identify areas where a financial process can become more efficient, such as improving the invoicing process by accepting multiple forms of payment, in order to accelerate collection from customers.
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Compliance and Risk Management
Another benefit of FPM is that it improves compliance by increasing the accuracy of financial reporting. Much like account reconciliations, FPM variance analyses can identify anomalies and errors in accounting data. Such items can be adjusted at the next accounting close or, if material, can be addressed immediately in post-closing adjustments — for example, during consolidation. Risk management benefits from having structured, recurring FPM analyses in place that provide timely alerts and enable businesses to pivot more quickly in the event of unexpected circumstances.
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Improved Cash Flow Management
An important aspect of financial performance and financial health is a company’s ability to meet its cash obligations. Unlike accrual-based profitability, cash flow management involves balancing cash inflows from sales with cash outflows, such as vendor, payroll and interest payments. FPM addresses this issue with a host of KPIs and ratios that specifically target liquidity and working capital, such as current ratio, operating cash flow ratio and the cash conversion cycle.
12 Steps in the Financial Performance Management Process
Achieving FPM’s ultimate goal of using reporting, planning and analytics to improve financial decision-making may take various shapes in different companies, reflecting each organization’s unique needs. However, to set up a new FPM process, the following 12 steps can serve as a good archetype.
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Strategic Planning
The first step is to define the business’s overall goals and objectives. Strategic planning should determine the business’s direction and set a path to get there. FPM then focuses on the financial goals that align with the strategic plan. These financial goals should be quantifiable, and the FPM measures selected should track progress toward those goals.
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Budgeting and Forecasting
The next step should be to put together a comprehensive budget that shows planned results, beginning with a budgeted income statement. From there, a budgeted balance sheet and cash flow statement can be prepared. The budget serves as framework for how to allocate resources to achieve the planned results. Forecasts update the budget to reflect the most current view of what is expected to happen. Forecasts should be updated as frequently as practicable so that business leaders always have the most up-to-date information at hand.
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Data Collection and Integration
This step involves selecting the KPIs, metrics and benchmarks to be used for measuring performance. It also involves identifying critical data and the way that data will be collected. It’s a best practice to include quality-control measures — such as data standardization, reconciliations and automated data integration — to ensure that information is accurate and consistent across the various financial processes.
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Monitoring and Reporting
Establish the methods and cadence to be used to monitor performance and report to key stakeholders. This likely includes setting up automated dashboards and regularly generating custom reports, in addition to providing the standard financial statements required for compliance reporting.
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Analysis
Step 5 is the core of FPM: analyzing the actual results. To do so, FPM analysts use many methods, such as ratio, financial and variance analyses, along with frequently monitoring KPIs and metrics. FPM typically follows a “manage by exception” approach, meaning that results that deviate from expectations, such as outliers or anything else deemed inconsistent with the strategic plan, are the first to be investigated more deeply.
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Performance Evaluation
This step involves research into and investigation of the items identified in Step 5. Understanding the causes of any variances goes beyond the numbers; it includes understanding internal and external qualitative factors that explain what is affecting performance. For example, it’s not enough to identify and quantify that a company’s bad debt expense has increased disproportionately to sales. The issue must be brought to an understanding of why — a rise in customer complaints about product defects, perhaps.
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Decision Support
In order for FPM to improve decision-making, its output needs to get into the right hands in the most understandable way. So, it’s vital to establish processes that enhance communication and collaboration between the management team and the finance group, such as regular meetings, publishing reports on collaborative software and getting buy-in from across the company.
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Performance Improvement
This step could be called, “So, now what?” It’s the stage at which company leaders must determine what actions to take to improve the issues uncovered by FPM analysis. This could mean corrective action to adjust operations to fix any problems that were revealed. Alternatively, it could mean reallocating resources to exploit a burgeoning opportunity that was discovered. Or, perhaps forecasts need to be recast to reflect a new reality.
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Technology Utilization
Throughout the entire process, technology can support better outcomes. It can make FPM easier, more accurate and timelier. Automated and integrated accounting and financial systems, together with robust data analysis tools, dashboards and flexible reporting, frees up staff time so that more effort can be spent on interpretation, research and formulating solutions.
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Compliance and Risk Management
FPM involves improving a company’s financial processes, such as the accounting close, in addition to its financial results. It relies on financial statements that are prepared in accordance with accounting standards, as well as other external reporting, such as tax returns and SEC filings, that are properly done and adhere to deadlines. By design, implementing FPM means that compliance reporting will be prioritized and increased attention paid to safeguarding the company’s assets.
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Continuous Learning and Improvement
FPM is an ongoing process that benefits greatly from iterative improvement. By including a mechanism that captures learning and improves the process, FPM can generate more, and more consistent, value. For example, by documenting the intelligence you gain when investigating a variance, you can avoid repeating the same hiccup in the future.
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Feedback and Adjustment
The final step is to establish a feedback loop that analyzes the results of the various actions undertaken in Step 8. What worked? What fell short? What fresh new issues were discovered while implementing the adjustments? This knowledge can improve future decision-making and inform the next cycle of budgets and forecasts.
Financial Performance Management KPIs
KPIs constitute one of the primary tools used to analyze performance. They provide a quantitative assessment of the item measured. A KPI is best viewed comparatively — over time (compared to previous periods) and versus budgets or industry benchmarks. It’s important to select the KPIs that best fit with the needs and goals of the business, in addition to the many basic KPIs that have broad application. It’s a best practice to set targets for KPIs and measure progress toward them. Eight of the most universal KPIs are explored here.
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Revenue Growth Rate
Revenue growth rate, also known as sales growth rate, shows the change in a company’s net sales from one fiscal period to another. Typically, the comparison is made to other periods in the same year, such as a monthly or quarterly growth rate, or compared to the same period in prior years, such as the first quarter of 2023 in relation to the first quarter of 2022. Revenue growth rate is expressed as a percentage, with a positive value indicating growth and a negative value indicating a decline. The formula is:
Revenue growth rate = [(Current sales – Prior sales) / Prior sales] x 100
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Net Profit Margin
Net profit margin shows a company’s overall profitability as a percentage of revenue. It’s helpful to use the net profit margin, rather than net profit dollars, to measure a company’s efficiency. For example, if a company makes $100 net profit on $1,000 of sales, is it better off than another company that makes $150 net profit on $5,000 of sales? Using the following formula shows that it is — the company with the lower profit has a higher rate of profitability (10% versus 3%).
Net profit margin = (Net income / Revenue) x 100
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Return on Equity (ROE)
Return on equity is another measure of a company’s profitability. It looks at how much net income a company generates in comparison to its average equity balance. Higher ROE is considered favorable. However, ROE varies significantly from industry to industry — industries with thin net profit margins, higher retained earnings and paid-in capital have comparatively lower ROE. When calculating ROE, it’s important to use the average equity balance for the same period as the net income. The formula for ROE is:
Return on equity = (Net income / Average equity) x 100
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Return on Assets (ROA)
Return on assets looks at how efficiently a company uses its assets to make profits. It compares net income to average total assets, expressed as a percentage. Higher ROAs are considered favorable, as it shows that fewer inputs (assets) are needed to generate higher net income. The formula for ROA is:
Return on assets = (Net income / Average assets) x 100
(where Average assets = (Assets at the beginning of the period + Assets at the end of the period) / 2)
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Debt-to-Equity Ratio
Debt-to-equity is a leverage ratio. It looks at how a company funds operations, using a mix of either short- and long-term debt or equity from shareholders and retained earnings. Lower debt-to-equity ratios are preferrable but should be viewed in the context of overall net income and cash flow. The formula for the debt-to-equity ratio is:
Debt to equity ratio = Total liabilities / Total equity
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Current Ratio
Current ratio is a popular metric for assessing a company’s short-term liquidity. It compares current assets to current liabilities. Current assets can be converted to cash within a year to cover current liabilities, which are amounts owed within a year. A higher current ratio shows that a company is more able to meet its short-term liabilities. The formula for current ratio is:
Current ratio = Current assets / Current liabilities
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Working Capital
Working capital is another way to look at liquidity, using the same components as the current ratio. Working capital is the difference between current assets and current liabilities, expressed as a dollar value. When current assets are greater than current liabilities, a company is said to have “positive working capital.” This is considered favorable because it indicates that a company can meet its short-term obligations. However, too much excess working capital may also indicate that a company isn’t investing assets to their highest potential. Extended periods of negative working capital are typically unsustainable. The formula for working capital is:
Working capital = Current assets – Current liabilities
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Budget Variance
Budget variances are a significant component of an overall financial variance analysis. They compare actual results to the planned results in a budget. Each budget variance is expressed in terms of dollars and/or as a percentage of the budgeted amount. Budget variances can be used to analyze any account, including sales, net income, expenses and assets. The nature of the account determines whether a budget variance is favorable. For example, if actual revenue is greater than budgeted revenue, the variance is favorable. However, if actual expenses are greater than budgeted expenses, the variance is unfavorable. The formula for budget variance is:
Budget variance = [(Actual result – Budgeted amount) / Budgeted amount] x 100
Challenges of Financial Performance Management
FPM brings many benefits, but it is a significant undertaking. FPM’s challenges mostly relate to the difficulties of doing it, difficulties that usually arise from missing or inaccurate information or the undue effort required because of hard-to-use financial systems. The most common challenges stem from poor systems integration, a company’s inability to adopt new technology and inadequate resource levels.
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Integration of Systems
FPM relies on a large volume of data that usually comes from multiple systems. When these systems are not well integrated, the data can be inconsistent, which can cause confusion and faulty results that, in turn, undermine the process. Lack of integration can lead to a significant amount of manual data re-entry/manipulation, which creates additional effort and can introduce errors and delays.
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Adoption of New Technologies
Legacy systems are often insufficient for FPM, so companies must adopt new technologies. If this is not possible, a company could experience a scenario where the right data to support FPM may not be captured, or where reporting is inadequate. In-house IT teams may not have the expertise or bandwidth to identify and implement solutions that can support and automate FPM processes.
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Resource Constraints
Resource constraints can be a significant challenge to FPM, which entails ongoing, and frequent, reviews and analyses of financial performance. FPM takes time and effort that may not be available from existing staff. In addition, there may also be a resource talent gap because FPM requires well-trained finance staff who also possess a high level of operational business understanding.
What Is Financial Performance Management Software?
FPM software combines various financial processes, such as accounting, reporting and financial planning, into a single system. This eliminates the need to manually pull information from disparate legacy systems. FPM software allows the accounting and finance teams to run financial statements and compliance reporting off the same shared information source as that used for customized reporting for analytics, like trend analysis and KPIs.
Manage Your Financial Processes More Efficiently With NetSuite
Achieving FPM’s goal of keeping a business financially healthy and high performing requires a financial solution that provides real-time reporting and analysis tools. With NetSuite’s cloud-based financial management software, accounting data and financial reports are always up to date, eliminating the typical lags associated with the closing process or generation of manual reports. Moreover, NetSuite financial management is only one of more than a dozen NetSuite enterprise resource management (ERP) modules, all of which share data in a unified central database. So, operational data from across the company can be automatically available and combined with accounting data, facilitating in-depth analysis of every area, including manufacturing, procurement, supply chain management, order management, customer relationship management, human capital management, project management, ecommerce and marketing. Role-based dashboards provide KPIs and key metrics, along with intuitive graphics and visualized trending data.
Financial performance management is a structured way to continuously monitor, analyze and improve a company’s financial performance and the performance of its financial processes. Its benefits can be significant and far-reaching, but, for many organizations, it is a daunting undertaking because it involves various types of analyses, such as variance analysis, trend analysis and KPIs. As such, it requires a large volume of time-sensitive data in order to yield the most meaningful support for decision-making. It’s accomplished best using cloud-based financial software on a platform shared with operational systems and data.
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Financial Performance Management FAQs
What is the difference between financial management and financial performance?
Financial management generally describes the controlling and organizing of financial information, to help ensure that a company is successful and compliant with applicable regulations. It is related to financial performance, which is the evaluation of that financial information in order to maximize the financial health of a business.
What are financial performance measures?
Financial performance measures include any metric that helps assess the financial health of a business. They include ratios and key performance indicators that relate to a company’s profitability, efficiency, liquidity, leverage and valuation. Common examples are net margin, return on assets, current ratio, debt-to-equity ratio and price-to-earnings ratio.
What are the 4 types of financial management explained?
Four types of financial management include budgeting and forecasting, financial reporting, financial analysis and profitability analysis. A company’s budget is a financial planning document that shows targets and planned resources for the year. Forecasts update budgets, based on what is likely to happen, using the most current internal and external data and predictions. Both are helpful yardsticks for comparisons with actual performance. Financial reporting is the process of generating financial statements, which are used by internal management and by external stakeholders. Financial statement analysis scrutinizes a company’s three primary financial statements and other compliance reporting to evaluate a company’s performance. Financial analysis includes a wide range of activities that involve collecting data and interpreting their results to evaluate performance, using methods like ratio analysis and trend analysis. Financial analysis is most insightful when compared over time to prior periods or to external benchmarks. Profitability analysis is the investigation of how well a company generates profit. It involves revenue optimization and cost management.
