Finance Byte - Week 1
Table of Contents
- Introduction
- Phase 1 - Start up
- Phase II - Running Business
- Finance Responsibilities
Introduction
From my reading of Strategy (still learning!!), I can distill the core essence of Strategy as
Value created by the company for their customers.
But then, who can actually check
- If a company is actually adding value?
- How much value is it adding?
- Is it adding value in the most efficient way ?
I believe the number crunchers in finance department has a unique vantage point in any organization to check all of the above . Why ? For that, let us first understand what does a number cruncher actually do?
Most of us who crunches numbers for a living come from accounting backgrounds & work our way up. Let us take the analogy of a start up.
Phase 1 - Start up
Our friends below have an idea they believe has traction & potential to grow into a multi-billion dollar company.
Now, these ideas need to be
- Tested
- Validated
- Converted to a MVP (Minimum Viable Product)
- Test the Product Market Fit
For all the above, the founder needs money or funds. There are multiple ways funds can be raised - either putting in their own money (bootstrap) or someone else can provide them (Venture capital, Banks etc). Let us assume they bootstrap the venture.
Now, in the midst of all their hard work in developing the product & their business, will they be able to focus on
- How much cash is being spent or burnt everyday ?
- What was spent till date?
- How much balance is left & for how long?
- Will the business run out of cash in the next 3, 6 or 12 months? or will it last only days?
- What assets does the business need & by when to plan production?
These and numerous other questions need to be answered & kept track of on a daily basis to ensure the business
- is spending cash on the critical aspects which will help them move forward towards their goals
- has enough cash reserves to last a reasonable time till they need the next round of cash
- knows how much cash they need & for how long
There has to be someone who can focus on their cash flows and that person would be the accountant who diligently checks &
- Reconciles Cash / Bank Accounts
- Tracks spending
- How much funds are left & for how long
Phase II - Running Business
Now, let us assume the business has crossed the start up stage & has a viable product(s) which is being manufactured & sold with additional borrowings & equity from external parties. There are additional dimensions to be considered here :
- The business is a running machine which needs cash for paying suppliers, wages to employees, rent, machinery maintenance, interest cost & other expenses
- The business serves paying customers who have use for their product which provides them income.
- There are external parties who have put in their funds or lent money to the business.
Now, the owners need to know
- Is the business generating cash to sustain the business?
- If not, what additional money would be required till the business sustains itself
- Would they need funding from banks? If yes, how much & by when?
- Do they need additional capital?
- What is the cost of acquiring this new money?
- What investments need to be made to grow the business? Will that money come from existing cashflows or new capital / debt needs to be raised?
Another very important question to answer is
Is the business making more money than the amounts spent or in other words, are they profitable?
Do you think these poor owners would be in a position to answer that on their own? Maybe there are owners who can but it is better to have a professional number cruncher to help them so they can focus on business development, customer acquisition & service.
On top of this, there are regulatory & compliance aspects to be considered (elaborated below).
You get the idea now. After having spent a majority of my career in finance & the last couple of years outside it, looking from outside in -
I believe finance department has a unique vantage point from where it can see & analyze whether anyone who uses money to start something is achieving what they started out to do & are they doing it efficiently so that they can achieve their stated objectives. How?
Finance Responsibilities
We can group finance responsiblities under two classifications :
- Keep the wheels running
- Add value
Lets take each of the above & explain through an analogy
Keep the Wheels Running
Assume that running a company is like driving a car. The owner or the CEO is the driver who drives the car.
The CEO along with the leadership team navigate the company through a VUCA (Volatile, Uncertain, Complex & Ambiguous) environment in line with strategy & they have to deliver on the strategy in the most efficient fashion.
To see if the car is running optimally, the driver checks the dashboard to check there is enough fuel or the car temperature is fine, no issues in engine etc.
In a company, the department which prepares, checks & presents that dashboard is the finance department. They prepare Operational Key Performance Indicators to check if everything is working the way it should.
Some examples of Key Performance Indicators (KPIs) are
- What is the cash flow forecast for the next 3, 6 or 12 months? Is it in line with expectations?
- Is the sales in line with the growth targets ?
- Is the cost in line with efficiency targets etc?
- Does the customer satisfaction score reflects customer happiness?
Also, depending on the industry, there are regulatory requirements which must be satisfied to ensure continuation of operations. E.g., For Public companies, there are periodical regulatory reporting requirements. E.g., SEC (Securities & Exchange Commission) Reporting in the US, compliance with Stock exchange regulations, loan covenants, tax regulation etc.
Banks have additional regulations with respect to maintenance of minimum capital, liquidity & treasury management. These need to be reporting periodically to the Central Banks.
Non-compliance with these regulations may result in fines or suspension of licenses or share trading etc. It will also result in reputation issues.
Hence, control over reporting to ensure accuracy of numbers is very critical & is a key component of Financial Controls and the ultimate flow to the dashboards.
If the above are not taken care of, the car cannot run or the company may not be able to continue operations. Hence, these responsibilities help to "Keep the wheel running"
Add Value
I believe finance department has the best vantage point to add value to ensure a company's strategy or objective are being met. How?
Only the finance department can track whether milestones are being crossed in line with strategy through checking performance against target or budget & help course correct where there are red flags.
Also, the strategy of a company involves various assumptions about the external environment, customer behavior, project milestones etc. While CEO is the owner of strategy, tracking implementation & ensuring achievement of each milestone falls under CFO responsibility. How?
Any strategy implementation involves :
- Additional funding which involves how much funding needs to be raised or whether new initiatives can be funded through current cash flows after ensuring operational requirements are met.
- Investments into required initiatives - This involves analyzing cash flows from investments & the assumptions behind it.
The above are normally done by Financial Planning & Analysis team with the CFO.
Also, finance department can add value by identifying efficiency improvements in operations. For e.g., working capital management by reducing inventory holding period, automation etc.
So, that in a nutshell is our introduction to the indomitable number crunchers & my new series on Finance Byte. We will get into more details on how finance is a critical part of any organization to keep the wheels running & add value at the same time.