As part of my ongoing series of articles on the role of a CFO, today I’ll be touching on the involvement of a CFO with the day to day running of a business.
In the course of my work, I have worked with founders and CEOs who have been running their businesses for years without a clear idea of their profitability, how much they would need to reinvest and how much cash they expected to finish the year with and as a result how much they would have to borrow.
This isn’t a condemnation or shaming of entrepreneurs. Quite the opposite. I applaud their courage especially when facing the unknown. I know how that feels as an entrepreneur myself. However, the right CFO or even a savvy accountant involved in the first few years could have made a world of difference in guiding these CEO’s to unlock the full potential of their businesses.
Let’s start with how a good CFO can be a strong driver of successful business strategy and operations. I have a client who has been running his business for over 15 years now. When he started, he captured market share quickly and grew rapidly as there was little competition. He was also in an industry that had very predictable revenue streams, customers that were bound to him for years and an enviable customer lifetime value. He had a wait list of future customers. This sounds like the dream situation for an entrepreneur but it led to sloppy financial and operational management due to the mindset that more cash will come in to cover the bills. He also had internal and external accountants to assist him. However, their contribution was limited to keeping the business compliant.
Eventually, new competitors entered the market. One in particular is well-funded, well organized and is very strong in operational management. The new competitor started capturing market share rapidly even though their prices were higher than those of my client. Things got worse as my client hired a CFO who was not qualified and was eventually fired. This was followed by covid-related lockdowns and restrictions which brought the business to a virtual standstill.
Business Strategy and Operations
In the above case, a good CFO would have worked closely with the management team from day one to ensure that the existing business strategy was still valid and then ensure that it was well supported operationally by processes and best practices.
The finance function is just once facet of business operations but it should be well-integrated to drive prudent decision making rather than be seen as a necessary evil. This requires collecting, analyzing and reporting relevant financial information accurately and in a timely way to support the management team in running the business. This helps reduce blind spots by casting spot lights on the core opportunities and weaknesses of the business.
This approach is what I see as P&L Co-Ownership or financial stewardship. Though the various department heads and ultimately the CEO is responsible for the financial performance of the business, the CFO shares that responsibility with them to ensure that they have the correct perspective to connect their operational performance with financial outcomes and vice-versa
The next step is to think about the diagnostic processes, tools and dashboards used to measure how well a business is doing financially in response to how efficiently it is run operationally. Each business and industry has a set of approaches and Key Performance Indicators (KPI’s) that are adopted but here are the common ones.
Financial Planning & Analysis (FP&A)
This is a personal favourite and was very much part of my early career. To me it is similar to an archaeologist deciphering hieroglyphs in a tomb to understand how an ancient civilization functioned. What were their customs, goals, high and low points. In this case, the hieroglyphs are the financial statements, dashboards measuring KPI’s and reports and the civilization would be a particular business.
Fundamentally, FP&A refers to budgets, forecasts, balanced scorecards or similar KPI dashboards and the thought processes and conversations behind them. An effective CFO will “partner” with the different departments in a business and understand how they operate individually and as a whole and translate this understanding in financial terms.
A budget is a yard stick and a forecast is an educated guess. To be effective, both have to be grounded in reality and used judiciously by management through a formal process of checking in periodically with the various departments of a business. There is a strong psychological element at play as department heads can be tempted to “sand bag” budgets which they will responsible for. Forecasts can also be manipulated to placate upper management and shareholders. A good CFO is able to understand this and navigate this occasionally tangled web to guide, unite and align management and the various departments.
Cash flow Management
This is related to liquidity management and refers to the specific actions taken to optimize a company’s cash flow. The first element is forecasting the cash flow for a business based on the three main sources of cash flow as found in a cash flow statement: Operating cash flow (from the core activity of the business), Financing cash flow (from debt, equity or other sources of capital) and Investing cash flow (associated with investments in or divestiture of property, plant, equipment, R&D and the like).
The forecast will provide insight on how much cash is expected to flow in and out of the business and when. It will also highlight points when the business may be low on cash or even have negative cash flow requiring additional capital or short-term cash infusions to cover operating capital needs. With this knowledge, the company could employ a number of strategies to optimize its cash flow. At the most basic level , closely manage accounts receivable and payables. If your customers pay you every 30 days and you pay your vendors every 60 days, you now have a cash buffer which you can use towards covering your operating expenses. For subscription based businesses a common strategy is offering discounts to customers who pay for a year in advance. Another area to free up cash flow is the reduction of interest costs by refinancing outstanding loans when interest rates drop.
Capital Budgeting
This is related to investing cash flow mentioned in the previous section and refers to the budget that a business allocates to growing its future productive capacity. This typically refers to assets like new factories, production lines, forklifts, trucks and computers. A healthy business will allocate a portion of its cash flow towards this on a regular basis to ensure that it keeps up with new developments and to replace aging or obsolete equipment.
OKR’s
OKR’s are an effective methodology for connecting strategy, operations and finance and refer to the “Objectives and Key Results” that define when an objective has been reached. Pioneered by Andy Grove at Intel in the 70’s it refers to a transparent, systematic process for individuals, teams and organizations to determine their most important goals and objectives and what it means and takes to achieve them.
While the COO may manage the OKR process for the company overall, an effective CFO should share responsibility for the process and provide insights on connecting strategic goals with financial goals. This enables the CFO to be a performance leader or growth champion while balancing the broader needs of short and long-term growth.
That’s a quick overview of a CFO’s operational management role. As you’ve probably understood by now, none of these occur in a vacuum but take place simultaneously. A good CFO is able to see how they interact and affect each other in real-time. In my next and final article on this topic, we’ll touch on some of the “soft skills” a CFO needs to be a good partner to the business.
Epilogue
As for my client from the beginning of this article, he has implemented a number of drastic changes across his business and has begun recovering market share and profitability. He now sees the situation created by covid as an opportunity to streamline his operations by reducing the size of his workforce and improving the training of those that remain. This has increased productivity and raised the quality of the services provided.
