It is evident these days that the finance function should make a contribution far beyond the traditional scoring roles. Gone are the days when accountants beat the books in a seemingly endless cycle and come home at the end of the day knowing it was a job well done. The modern CFO is the CEO’s right-hand man. They are expected to be experts in almost all matters of their organization and at the same time maintain and improve their profile as a strategic leader. So often caught up in the tactical and even operational issues that all of this entails, it can seem like an intimidating prospect to contribute and even lead the strategic direction. Below I discuss a simple plan for how this can be done.
Before we get into the plan, however, let’s refresh our memories on some basic strategic principles. Table one describes some examples based on the foundational work of strategy grandfather Michael Porter.
How does finance contribute to company strategy?
Table 2 takes a quick look at some of the main areas that finance can contribute to overall business strategy.
The main contribution of finance to the overall strategy of the company is to ensure that it is ultimately “bankable”
It is worth making a few observations. First of all, as Treasurer I have to say this: Survival is the absolute fundamental goal of the business and operational, management and finance functions should always be aligned behind this goal before profit. short term. Second, strategic direction is the greatest risk to survival. This is easily forgotten and does not minimize the myriad of other risks facing a business. But if the strategy is wrong, there is nowhere to go at the end of the day. The last point I would like to make is that the other areas listed are all performed more or less efficiently by the traditional finance function. But let’s face it, strategy tends to be seen as a separate function, often the preserve of an elite team that distances itself from the essential details of the finance function.
So how does the Blueprint work?
The two areas the master plan focuses on are risk management and value measurement. Finance has many possibilities to go beyond its traditional contribution and, to be frank, limited to these two areas. This increases the chances of defining and executing a successful strategy. By applying the principles of risk management to the strategic planning and review process, the elements of discipline and planning are enhanced. And by being able to measure value, not profit, incentives and capital allocation can be fully aligned with value creation.
Figure 1 illustrates how these areas, reserved for finance, can make business strategy “bankable”.
The message in Figure 1 is that strategic direction is the greatest risk a business faces, and strategy without measurement is a shot in the dark. Traditional accounting is limited in its ability to take both measures into account. But not anymore. By broadening our vision of what it can bring and by embracing and championing new techniques, the finance function can move away from its traditional role and assume the role of strategic leadership. Based on established corporate finance techniques, it simply requires the financial community, in its new role as financial strategists, to think and apply their skills a little differently.
Risk and strategic planning
If strategy is the biggest risk the business faces, that logically implies that it should be assessed within a risk management framework. Why treat strategy differently from other risks? Taking the right risks is at the heart of a good strategic choice. Tools such as SWOT, Porter’s Five Forces (Michael Porter, Harvard Business Review, 1979) and value chain analysis (Michael Porter, Competitive Advantage: Creating and Sustaining Superior Performance, Free Press, 1998) all shed light on the skills and strengths of the business and the risks identified in the strategy should be aligned with these. Risks that impinge on weaknesses and non-essential skills can be identified and the appropriate response can be formulated. It’s not rocket science, but setting strategic decision making within a risk management framework really adds clarity to whether things are stacking up or not.
Strategy setting within a risk framework brings a new perspective and discipline to the strategic planning process.
Value measurement and capital allocation
Traditionally, finance has measured profits and, to a much lesser degree of analysis, cash flow. Returns on capital are often misunderstood. Add in the dimension of the degree of risk taken to generate the declared profit, which traditional accounting completely ignores, and the limits of a vision of value centered on profits and losses are obvious. On the other hand, investing activities are generally valued using a discounted cash flow methodology based on cash and risk. Why is it universally accepted that we look at investing activity and financial performance from these two completely different perspectives?
Let me ask you the following question: Do you know which parts of your business are creating or destroying value? Does your strategy really work in financial terms? Do you see the returns on capital that you expect?
Traditional accounting has severe and potentially destructive limits in the areas of capital allocation and setting goals aligned with strategy and value. Yet, value can be easily measured from internal management information readily available in virtually any business. The technique is straightforward and is based on the premise that if you are happy to use the discounted cash flow methodology when considering a CAPEX investment or merger and acquisition decision, then why not apply the same approach when looking at them. performance or budget of business units within the company? You can measure value directly from your financial statements, it’s easier than you might think and as flexible as your imagination allows. Again, not rocket science, just a will to look at financial data in a different way.
In the following articles, I will describe in more detail how a risk management framework can be integrated into the strategic planning process and how value can be measured in practical terms. Both processes are simple, transparent and easy to apply. Additionally, I will introduce the Monte Carlo simulation, the gain-loss gap, and argue that the WACC is not the correct minimum rate of return for determining value in the business environment. Another critical rate of return that reflects the capital constraints a firm faces and the growth pressures that investors exert on the firm through their valuation is proposed. My website, mwacc.fr, takes its name from this new minimum rate of return.
The author, Ben Walters, FCT, ACA is a practicing corporate treasurer with a keen interest in the practical application of corporate finance in the real business environment. He believes that finance can better support strategic analysis and improve the overall value of the company and has developed innovative thinking in this area. He is always eager to be contacted by [email protected]