Comment

CFO as business partner

Apr 01, 2019
As the CFO role moves away from reporting and accounting compliance, here are 10 ways to become a strategic business partner.

In recent decades, the role of the industry-based CFO has evolved. The traditional focus on reporting and accounting compliance has been replaced with a requirement to fulfil the role of business partner – but how can one act as a good business partner? Here are 10 ways a CFO can offer useful strategic insights to their CEO.

Measure your firm’s return on invested capital

If a firm consistently generates a return on invested capital (ROIC) in excess of its costs of capital, its shareholder value and equity value will grow. The converse is also the case. ROIC is therefore the critical financial measure of how well your company is performing.

Drill ROIC analysis as far down your company as possible

ROIC equals operating profit less tax divided by capital employed (i.e. debt plus equity). The further down within the company ROIC can be measured, the more insights you will gain as to which activities are contributing to growth in equity value and which are not. ROIC should therefore be estimated for each division, geographic unit, product and even customer (if that is possible).

Act on the insights offered by your ROIC analysis

If the ROIC being generated by any activity is insufficient, the choice is simple: restructure, sell or close. There is one caveat: avoid prematurely exiting an activity at the bottom of the business cycle when its ROIC will be lowest: prospective ROIC over a full business cycle needs to be considered in making such a decision.

Allocate investment capital where it will get the best ROIC reward

Kerry Group and Glanbia have successfully migrated to the high-return food ingredients industry, having originally been dominated by commoditised dairy activities. That is the fruit of investment decisions made over the last two decades – to favour food ingredients over dairy, which must often have been politically difficult.

Consider diversification opportunities adjacent to your existing activities

Expanding into neighbouring areas is easier and considerably less risky than making a “with one leap, our hero was free” plunge into the unknown. Making more effective use of whey, a by-product from their dairy activities, prompted Kerry Group and Glanbia to successfully move into food ingredients.

Seek expansion opportunities that expand your market share

In general, investment returns are positively correlated with market share: bigger is generally better. Identify whether this rule applies in your sector. If it does, seek out expansion and acquisition opportunities.

Boost investment levels and acquisition activities when markets are depressed; scale them back and consider disposals when markets are euphoric

The average annual return on the S&P 500 when the US unemployment rate exceeds 7% is 11.2%. The average return when unemployment is less than 4.5% is a mere 1.3%. As of January, the US unemployment rate was just 4.0%. That suggests that, at this late stage of the business cycle, it is a better time to be divesting than investing.

Have a clear-headed idea of the value of the different elements of your business and take the money if you are offered more than they are worth

Too many firms are so wedded to their industry standing (“we want to be a world-leading manufacturer and distributor of X”) that they overlook attractive asset disposal opportunities. Be flexible enough to take the money if you are offered more than a business is worth.

If you are a publicly-quoted company, apply the adage “buy low, sell high” to your own shares

The value of your shareholders’ position can be boosted by share buybacks (when your shares are trading for less than their underlying value) and by using your shares as acquisition consideration (when they are trading for more than their true value).

Replace expensive debt with cheaper debt

If interest rates have dropped or your firm’s riskiness has been reduced, you may be able to cut your firm’s interest expense by refinancing your debt.

Cormac Lucey is an economic commentator and lecturer at Chartered Accountants Ireland.