CFOs need to determine suitable capital investments to drive long-term value amid rapid pandemic-era market changes and as stakeholders focus on changing measures of progress. How can they track the right metrics to make these decisions? The answer lies in developing a balanced scorecard.
Qualitative factors, especially those that measure environmental impact, diversity goals, and workplace safety, are joining standard financial metrics in defining a company’s progress.
CFOs are challenged to put these nonfinancials on equal footing with growth rate, free cash flow, and other financial measures. EY teams have helped clients implement a balanced scorecard approach, which assigns value and weight to all metrics — quantitative or not — to help inform capital allocation decisions and enable more effective monitoring.
Investment cases that include these balanced scorecard approaches provide a more consistent framework to evaluate investments and form the foundation for prioritizing and approving capital investments.
The key to effective capital allocation is using an objective framework to drive the analysis, prioritization, and execution of every strategic initiative. But the framework is only as good as the metrics that go into it. In the EY 2021 Capital Allocation survey, most (64%) CFOs noted that qualitative metrics are becoming more important in the capital allocation process, making the selection of metrics or key performance indicators more complicated.
Given that a sound investment case should include quantitative and qualitative KPIs, companies need to choose the KPIs that correspond to and measure those strategically essential elements. If societal benefits are part of a company’s mission, then social equality, carbon footprint, or water consumption might be included as KPIs. Customer value can be reflected in metrics such as satisfaction and net promoter scoring, while the value for employees could be measured in engagement, retention, and health and wellness.
When evaluating a capital investment, qualitative KPIs can help show how a potential investment or acquisition can aid or hinder the company in achieving its long-term strategic goals in a way that the financial KPIs may not reflect. For example, will an acquisition help the company increase its customer retention rate with new products or services? Would investing in new factory technology reduce an organization’s carbon footprint? Could acquiring a specific target increase operational complexity and slow time-to-market for new products?
Once the appropriate KPIs are determined, they need to be weighted based on the importance to achieving strategic priorities. For example, environmental, social, and governance (ESG) metrics could receive a higher weighting than they may previously have. Measures of the time it will take to achieve a goal, or the organization’s ability to execute this type of project successfully, could also be tracked.
Quantitative metrics can also be weighted and should not be neglected. A company should ensure that the overall portfolio of approved projects can still generate the returns necessary to achieve its long-term strategic objectives and satisfy stakeholder obligations.
Once the KPI’s weighting is determined, the actual metric needs to be assessed and scored. Is there a high likelihood it will improve market position? Will it have a low impact when it comes to improving diversity and inclusion? Combining the weighting and the assessment will result in a score that allows qualitative metrics to be compared across different projects and sets a goal for monitoring or tracking success.
One way of doing this is through a Pugh Matrix, a chart that lists the specific criteria, the weighting, the assessment, and the score. For example, one advanced manufacturing company had numerous qualitative metrics that it was considering in project selection, but they were doing so on a subjective basis. We developed a Pugh Matrix that enabled the company to incorporate these qualitative metrics into their capital decision-making framework. The result was a multibillion-dollar strategic investment program that improved the company’s market position and was well received by both shareholders and employees.
Once the KPIs are determined, weighted, and scored, the next step is to bring the information into a balanced scorecard. The scorecard provides a framework for the holistic assessment of individual investments across quantitative and qualitative metrics and helps decision-makers compare alternatives.
In addition to using balanced scorecards, many companies adopt online dashboards to drive a higher level of transparency and efficiency in capital allocation decisions. Some solutions take technology a step further and incorporate databases to act as a repository of capital investments and link directly into a company’s enterprise or financial systems.
While balanced scorecards can enable more effective investment decisions, they also drive agility through greater efficiency and transparency. Given ongoing market disruptions, increasing agility is top of mind for most companies. Embracing a balanced scorecard approach to capital allocation is a logical first step in the journey to agility.
Loren Garruto is EY’s global and America’s corporate finance leader and Ben Hoban is a senior manager, strategy and transactions, Ernst & Young LLP.
The views reflected in this article are those of the author and do not necessarily reflect the views of Ernst & Young LLP or other members of the global EY organization.