Driving company value and growth by leveraging your company finance function
In light of complex regulatory requirements, increased innovation, emerging technologies and change in client expectations, the Finance function needs to rethink its operating model in order to enhance its contribution to the value creation of the company.
Finance is often viewed as a back-office function, combining transactional and accounting activities (payable, receivable, general ledger, payroll administration, production of financial reports). The transactional activity is clearly critical to the finance function but can be partly automated using new technologies such as robotics, blockchain and artificial intelligence. This represents an opportunity for finance people to allocate more time to business partnering activities, such as forecasting, investment decisions and business intelligence. In this article, we look at value drivers shaping the finance function and how they can be implemented.
1. Provide insights analysis for a better decision-making process
Finance needs to go beyond the accounting model and support the decision-making process, acting as a financial business partner. Increased visibility of financial information is currently a key success factor to boost the company’s performance and create value. i.e. analyze the performance of business units to be aligned with the company’s strategy.
According to PWC, less than 25% of Finance’s time is spent delivering business insights. It is important to free up time from non-strategic activities.
Finance can provide insights and support the decision-making process with relevant data and analysis in many areas:
Change the business route
Align KPI/Metrics to strategy
Calculate the lifetime value of clients
Identify technology & restructuring solutions (Share service centers, AI..)
Support analysis of operational and financial risks
Highlights markets, customers, services & products which drive profitability and provide growth opportunities
Monitor supplier costs and improve procurement initiatives
Work on company valuation
2. Align KPIs (Key performance indicators) to strategy
KPIs/metrics are only valuable when they are aligned to strategy and result in defined actions. In most companies, the finance function is the owner of the KPIs (definition and calculation).
A business first needs to define its objectives and determine which processes need to be measured. This will require the involvement of all business functions.
As per Bernard Marr: « think about KPQs: Key Performance Questions. This will help you work out which data need to be gathered, and, therefore, which KPIs you’ll find most useful “
In order to build effective KPIs, you need to identify the data, define the correct measurements metrics and decide who owns the KPI.
KPIs are differentiated by functions and industries; Sales Managers, for example, will be interested in quarterly metrics, revenue, and wins by type and prospects by stage.
KPIs are also critical when working on scenario planning to analyze the impacts of change drivers.
We recommend including KPI’s in executive business dashboards, in order to summarise complex information and present it in an understandable manner. They are numerous Data Analytics and dashboards tools which you can find on the web to support this process.
More than 50% of companies in the US used balanced scorecards to review performance indicators.
Client KPIs
Finance can help you understand your client KPIs and take the best actions based on:
Client market share of your total sales
Client contribution to the bottom line
Client Lifetime value
When was the last time you focused on profitability by client, channel & market?
This analysis can highlight customers that consume a lot of your time, but don’t add much to the top and bottom line and identify upselling opportunities with other customers.
3. How to communicate Financials to stakeholders
Value creation will only happen when the communication process is clearly defined between the Finance function and the other stakeholders. Non-finance people sometimes wonder if finance/accounting people speak a foreign language.
It is the Finance function’s responsibility to improve the communication between finance and other departments. KPI’s and Dashboards are part of the tools that can be used to better communicate financial information.
Improved communication can have many benefits and significantly contributes to value-creation by:
- Delivering clear analytical reports allowing senior management to easily review business performance and take the best decisions
- Highlighting the cost and revenue drivers
- Improving forecasting and budgeting through increased collaboration
- Creation of new business opportunities. Finance needs to communicate the future, not just the past
- Effective finance communication can also affect the share price and cost of capital (i.e. Tesla)
- Providing insights to top management for a better decision process, to respond to this critical question: Is the company performing as per strategy?
Communication & employee engagement
One of the main benefits of communicating financials is employee engagement. Sharing company results by profits centers to the entire staff on a quarterly basis empowers all employees. CFO’s should explain the results, revenue & cost drivers for each profit center, as well as the working capital constraints. Using a bottom-up approach to report financials to management can be also a great strategy to move financial ownership to teams and engaged employees.
A regular workshop in cash-flow management organised by the Finance function should also be scheduled. Cash is the lifeblood of the company and a good barometer to help understand the quality of the services provided.
Communication and the budgeting process
The main value of the budget process is the connecting thinking between all actors of the company. The projected result is not as important as the cross-functional analysis required to lead to this result.
We therefore highly recommend top management uses the budgeting process to reshape the landscape, examine new horizons and connect with others.
You also need to consider also qualitative KPIs and long-term goals when analysing your client base.
In general, it is important to diversify the client-base and not depend on one large customer.
4. Understanding the meaning of « Leverage » in business
Understanding leverage is quite critical when a company is seeking growth and value creation. Investors usually turn to leverage to gain a higher return on assets. Using simulations, the Finance function needs to share insights on the drivers impacting leverage with the management team.
Operating leverage and financial leverage both amplify the changes that occur to earnings due to fixed costs. In highly leveraged positions, the risk of important losses is increased. A higher leverage also implies higher business risks.
Operating leverage magnifies changes in earnings before interest and taxes (EBIT) as a response to changes in revenue. Operating leverage measures a company’s fixed costs in its cost structure and how a change in sales volume affects the company’s profit. Also called operation gearing, it is one of the major components of operating risk.
In case of high operating leverage, a large proportion of the company’s costs are fixed costs. The firm earns a large profit on each additional sale, but must achieve a sufficient sale volume to cover the amount of fixed costs.
As a result, the risk of the business with lower operating leverage is lower, but the earnings can be more interesting with the 2nd scenario.
Financial leverage is the amount of debt that a company uses to purchase more assets. Employing leverage is common, as investors don’t usually only use equity to fund operations. It is critical that the profit made from the investments is greater than the interest paid, to avoid a negative leverage which would put the company in a difficult position.
It is the CFO’s responsibility to increase awareness about leveraging and operational risk within the management team.
5. Capital budgeting
For the Finance function, capital budgeting is about determining whether a business project, such as a new investment, an acquisition or a restructuring plan, will increase the firm’s value.
In essence, it is the case if the present value of the future cash flows is expected to exceed the initial cash investment or in other words, if the net present value of the project is positive. If the value is negative, we are looking at value destruction.
Firms typically finance their investment projects with a combination of equity capital and debt capital, and both shareholders and debtholders require a return from their contribution to the financing of a project.
In case of low operating leverage, a large proportion of the company’s costs are variable costs and it only accounts for these costs if there is a sale. In this case, the firm earns a smaller profit on each additional sale, but does not need to have a high amount of sales in order to cover its fixed costs (breakeven point).
When a project is funded with equity and debt capital, the cost of capital is equal to the weighted average cost of capital.
To illustrate this, suppose a 5 years project will be financed 40% with equity and 60% with debt. Also, assume this project has an estimated cost of equity of 10% and an after-tax cost of debt of 5%. The project's weighted average cost of capital or WACC will be equal to 7%. If the cash flow generated and discounted at a 7% rate is higher than the initial investment, it is then worthwhile investing.
As per the time value of cash theory, the WAAC will be used to discount the cash flows to their present value.
There are numerous methods to calculate the viability of projects and finance needs to clearly explain the assumptions used for a better decision process.
6. Finance at the core of corporate governance and ethical behaviour
In today’s strong regulatory environment, valuation is also about long-term sustainability. This can only be achieved with a management team focus on strong governance and ethical values.
The CFO has a good “helicopter view” of the business to safeguard the governance requirements of the company. Finance is also the main provider of business intelligence.
Financial governance includes everything from internal controls and audits, workflows and reporting integrity.
7. Conclusion
One of the main roles of the Finance functions is to provide insights and leverage digital solutions to focus on value-added tasks. Supported by technologies such as RPA, blockchain, AI and the Cloud, the finance operating model must be driven by agility and efficiency.
We clearly need to differentiate the transactional/accounting activities and business partnering. A majority of companies have already defined different roles for these 2 activities.
The role of the CFO is increasingly moving from back-office controlling to business partnering. According to Deloitte, more than 70% of CFOs think that Finance is a driver and supporter of growth, innovation and transformation.
Communication within cross-functional teams has become highly important. The success of this collaboration can only be achieved if the Finance function acquires business knowledge and the business gains a solid grounding in Finance. It is more challenging to play in the same team if you don’t speak the same language.