Innovation is critical for organizations because it establishes a foundation for long-term survival. So how can finance measure innovation? Simple—inspect what you expect.  

Innovation is critical for organizations because it establishes a foundation for long-term survival. The outputs of innovation are visible in the creation of entire new categories of products and services, or better ways of getting work done. But how can an organization know if the inputs exist that lead employees and management to focus on innovation? One way is to measure the activities and processes that may lead to the outcome you. After all—you inspect what you expect!

This article provides insights and suggestions to help the finance function measure the precursors of innovation. While it may be impossible to fully measure innovation and measuring innovation probably should not reside solely in the finance department, this is a way that finance and FP&A professionals can help colleagues maintain focus.

A “BALANCED” APPROACH

In 1992 Robert Kaplan and David Norton created a measurement system called The Balanced Scorecard. The Balanced Scorecard went beyond financial statements in measuring what businesses do in order to improve performance. Going beyond financial statements meant adding perspectives and points of view to evaluate performance. Evaluating performance through The Balanced Scorecard is measured from the perspective of finance (Financial) and also the perspectives of customers (Customer), processes (Internal Process) and employees (Learning and Growth). Our measurement of innovation is made by seeing through the eyes of others.

Seeing through the eyes of employees is the first step because employees affect the processes, interactions with customers, and ultimately the bottom line of financials. Failing to effectively measure innovation through their eyes may hinder the measurement of innovation through the other perspectives.

Examples of employee measurement include ways to measure employee engagement and conversion to testable ideas:

• Number of Employee Suggestions. This measurement creates insights into employee engagement. Without employee engagement, organizations will fail to move forward because employees will be stuck in the status quo, an existence that contradicts the effort to achieve long-term survival.
• Number of Employee Improvements. Innovation is about improvement. Improvement can be in the form of new facilities layouts, new methods (production, selling, and administration), and new ways to interact with customers.
• Number of Employee Prototypes. Prototypes are preliminary models of products but also can be preliminary types of service. Creation of prototypes are necessary to test the effectiveness of new ideas.

DIFFERENT PROCESSES

Processes serve as a bridge between employees and customers and encompass the creation, promotion and support of what organizations sell. Examples of process measurements include:

• Percentage of New Products Sold. This measures the relationship between the number of new products an organization sells and the total number of products sold. It measures the ability of organizations to generate interest in the ideas made by employees.
• Percentage of Products Shipped by Number of Days. This measures the relationship between the ability of functions to fulfill customer requests. Fulfilling requests in a timely manner is a way for an organization to stand out from its competition.

CUSTOMERS

If customers have positive perceptions through innovative employees and processes, customers are more likely to buy from organizations. Examples of measurements that help us see through the eyes of customers include:

• Number of New Customers. New customers validate an organization’s value proposition.
• Number (percentage) of Customers Retained. Existing customers validate an organization’s effort to fulfill customer needs in part through innovation, and is the inverse of the Churn Rate.
• Percentage of New Products Purchased. This measurement serves as the ultimate connection between an organization’s innovation and a customer’s acceptance. This connection means employees and processes are in sync with the marketplace.

FINANCE

Simply put, being unable to meet stakeholder needs puts an organization on the path to insolvency. Examples of measurements that help finance innovate include:

• R&D Expense As a Percentage of Sales. Research and Development is a financial commitment to innovation. Expressing this commitment as a percentage of sales indicates a relationship between effort and reward.
• New Product Sales As a Percentage of Total Sales. The emphasis on this percentage should be on the price of new products sold.
• New Fixed Assets As a Percentage of Total Fixed Assets. This percentage represents a commitment to acquiring physical capital like factories, warehouses, and equipment. This commitment indicates an importance that an organization places on physical capital that can increase revenues, decrease expenses, or both.
• Intangible Assets As a Percentage of Long-Term Assets. Intangible assets like intellectual property represent investment in ideas—the ultimate form of innovation.
• Net Cash Provided By Operating Activities As a Percentage of Total Long-Term Assets. Net cash provided by operating activities appears on a statement of cash flows. This element indicates an ability of an organization to conduct meaningful relationships with its customers, employees and vendors. Measuring this relationship by comparing it to an organization’s assets provides insights into an organization’s ability to use its fixed assets and intangible assets for customer satisfaction, and is more informational than a simple return on assets calculation.

Innovation is about turning ideas into reality. Ideas are real when employees, processes, customers, and finance are united in their acceptance. How you can see this acceptance is by measuring innovation through the concept of The Balanced Scorecard.

	EMPLOYEE	PROCESS	CUSTOMER	FINANCE
Suggestions
Improvements
Prototypes
New Products
Products Shipped
Information Provided
Customers Acquired
Customers Retained
New Products Purchased
R&D %
New Product %
New Fixed Assets %
Intangible Assets %
Operating Cash

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Want to see how FP&A can work better with other lines of business? Check out AFP’s How FP&A Can Become a Better Business Partner guide for more information.