Pt 1 - Six Characteristics of Management Information

Six Characteristics of Useful Information

During my management accounting career I discovered six characteristics of useful management information: (1) relevance, (2) comprehensibility, (3) reliability, (4) significance, (5) timeliness, and (6) action-orientation.

I do not recall exactly where I picked these up, but I practice these criteria and disseminated it to the teams I lead.  In this blog and the next, I will discuss these criteria and methods to achieve the criteria.

Relevance

In order to support a management decision, information provided must be related to the management issue at hand.  To illustrate I refer to a past experience.  In a given month on the financial statements the product refunds was higher than usual, at about 30% of sales.  The immediate interpretation was that customer satisfaction was very poor, suggesting the business was not delivering on its promise. 

However, we took a second look using management information systems to reveal a different story.  Product management had extended the refund policy on our best selling product to 60 days, and sales of this product were very strong six to eight weeks ago.  Exacerbating the situation was naturally low sales in the current month as per seasonality. 

When we took a sample of shipments and calculated product refunds it was 5%, in stark contrast to the initially reported 30%.

In this case, the revenue line reported current month sales, and the contra account reported refunds related to sales one to two months earlier.  This incident illustrates that while the financial statements were relevant to understanding actual transactions occurring in the month, they were not relevant for calculating a product refund rate.

Comprehensibility

Management information must be understandable, and this is achieved through both content and presentation.  Analysis is usually quite complex and requires creative methods or advanced mathematics.  Many analysts tend to explain methodology in excruciating detail, partly to exhibit their brilliance (I was guilty of this early in my career).  However, many managers do not know a correlation coefficient or F-score from Einstein’s theory of relativity, and they do not care.  Instead, they only care about the conclusion, and maybe a top layer explanation of root causes.  

In addition, many managers are on the receiving end of immense data tables packaged as “reports”.  Instead, figures should be summarized at a high level and presented succinctly.  I have a preference for exhibiting data in charts, as “a picture is worth a thousand words”.  Trends and patterns are also more easily recognizable in charts.  Management should be able to glance at the report and comprehend quickly the message.  I recommend providing information in brief, and in back up materials provide drill down levels of supplementary information if requested.

Reliability – Management information must be truthful, accurate and transparent.  Management metrics should measure appropriately the desired incidence, such as the product return issue mentioned above.  While management information must be accurate, because of the timeliness of useful management information, there is a tolerable margin of error. 

In order to deliver weekly or daily information, estimates or standard costs may be necessary.  The key is to regularly validate that the margin of error is within tolerable levels and relatively consistent.  As for transparency, methodology should be documented and available to stakeholders, rather than being a “black box”.  Being able to explain methodology lucidly to stakeholders instils confidence in the information.

Reliability also reflects that the information is available when required, and the formatting will be consistent.  Management does not want to have to hunt for figures in constantly changing report formats.  Rather, they want to know where they can regularly find the metric required. 

In my next blog I will discuss the remaining three criteria.

High returns from reporting automation

In my experience the role of a business analyst is a conundrum.  As the title conveys, the business analyst analyzes financial and non-financial data to identify management insights that support decision making.  The role requires creativity and ingenuity, and at times is more art than science.  However, as management, recognizing the value of the ad hoc investigation, expects that information to be provided regularly the role becomes a quotidian reporting role.

When this happens I find the situation quite unfortunate as it squanders the business analyst skill set, and at $50k to $100k salary it is not a good use of company funds. 

The solution is report automation.

Management is often resistant to automation because it requires an investment, time and money, as well as a sacrifice of immediate benefits for distant benefits.  However, there is a compelling business argument for automation.

Report automation can provide an incredible return on investment (ROI).  For illustrative purposes, suppose a report that requires 4 hours per week can be automated with 16 hours of development work.  The payback period is 4 weeks (or 4 reporting cycles), which is calculated from 16 hours investment divided by the periodic return of 4 hours.  And over a one year period, 192 hours of capacity (48 weeks times 4 hours per week) will be returned to the team, which results in a return on investment of 192/16 = 1200%.

The other major benefit of automation is improved reliability by mitigating human error.  It is only natural that reports created manually are at risk of calculation error because, to coin a phrase, we are only human.  I point out that a business analyst may conduct thousands of calculations per day within his spreadsheets, and one error, while frustrating for our stakeholders, is a low error rate (1/1000 = 0.1%).  Report automation allows the computers to conduct the routine calculations and allows us humans to conduct investigative analysis requiring creativity and ingenuity, traits computers do not possess.

I have two analogies that illustrate the value of report automation.

First, consider a glass to represent the capacity of the business analysis team.  As new demands are placed upon the team, the glass fills up to the point where it is either full or overflowing (quality and delivery suffer in this case).  In order to put some more in the glass, some has to be spilled out.  Report automation spills some out and creates capacity.

I realized the second analogy as I was inching through the construction zone at the east side of the Port Mann Bridge.  Anxious to return home, I muttered why this construction has to be done today.  I then realized that is exactly how management thinks – they need information today.  However, when construction is completed our commute is invariably improved, and the efficient roadways support municipal growth.

Report automation is development of an infrastructure that supports continued growth and efficiency.

What is management accounting?

When networking, I introduce myself as a management accountant.  Invariably, I am asked what is a management accountant.  Most people are familiar with accountants as the bean-counters, number crunchers, preparers of accounting statements, and so on, but few understand the distinction between financial accountants and the management accountants.

In short, I explain, the financial accountant prepares information for stakeholders external to the organization, whereas the managerial accountant prepares information for stakeholders internal to the organization.

And I continue to explain some of the differences:

Financial accountants focus on past and present, and managerial accountants focus on future. 
The financial accountant prepares financial statements that describe the current state of a business (Statement of Financial Position) and past performance (Statement of Income), most often for the business as a whole.  The managerial accountant analyzes past performance as an indicator of future performance and reports to support management decisions and planning.  Rather than the business as a whole, management accounting tends to focus on components of a business, such as product lines or divisions. 

Financial accounting is precise, whereas managerial accounting is timely.
Because external stakeholders such as investors and creditors rely on financial statements to evaluate the riskiness of an organization, there is an expectation of exactitude in the figures.  To ensure precision, sufficient time must be given at the end of the reporting period for accountants to compile all transactions and verify the results.  However, management information needs to be timely as management is perpetually making business decisions.  There is a recognized trade-off between accuracy and timeliness, and sometimes figures are at best an estimate based on available data.  This is acceptable provided the margin of error is not significant enough to lead to a different decision.

Financial accounting is, well, financial.  Management accounting involves both financial and non-financial information.
As the name suggests, financial accounting largely focuses on the reporting of financial information.  Financial accountants' primary concern is transactions involving monetary exchange.  On the other hand, management accounting is concerned both with financial information as well as non-financial information. For example, as a management accountant I have analyzed product return rates, extracted call centre acquisition rates, conducted customer segmentation, studied attrition rates of subscribers, and conducted statistical analysis of TV advertising response rates by media channel.  The management accountant needs to be able to analyze the drivers of financial performance, which are not always financial.

Financial accounting has to follow rules, whereas management accounting is free from rules.
Because of its obligation to report actual performance to external stakeholders, financial accounting must adhere to laws and regulations, such as securities laws, GAAP and more currently IFRS.  Every publicly traded organization must prepare audited financial statements, and for tax purposes private organizations also require financial statements.  Because management accountants' stakeholders are internal and rely on the information for planning and decision making, the management accountant can break the rules provided the reasoning is relevant to the management issue.


Finally I explain to my new networkees that the primary three accounting organizations in Canada have their respective specialties: Certified General Accountants (CGA) specialize in the preparation of financial statements and taxation; Chartered Accountants (CA) are experts in auditing and forensic accounting; and Certified Management Accountants (CMA) specialize in turning information into management insight.