CFOs are the unsung heroes in terms of financial transformation on PE investments but the experience gained during this transformation process prepares them for higher responsibilities including Board positions and helming the business...The Advent of the PE (private equity) gives great joy to the promoter group and establishes valuation and success for business built over the years. The...
CFOs are the unsung heroes in terms of financial transformation on PE investments but the experience gained during this transformation process prepares them for higher responsibilities including Board positions and helming the business...
The Advent of the PE (private equity) gives great joy to the promoter group and establishes valuation and success for business built over the years. The PE investments go towards areas like retirement of debt, future expansion, cashing out by existing promoters etc. A change in a company's ownership also requires significant changes in its finance organization. This is especially true when the new owner is a private equity ("PE") firm. PE firms have huge appetite for data, particularly financial data of what drives a business. PE firms may change the company strategy to create value for shareholders. In such situations, a company's CFO, as well as other functional areas, have to align themselves and support the new direction.
PE requires the CFO to create value by combining financial expertise with key operating facts to make business decisions. A traditional company's finance organization may generally be subsumed by its monthly process and status quo. While the accounting process requires significant efforts of the finance team for recording of large volumes of accounting transactions and management of ERP systems followed by consolidated financial statements, there is limited strategization expected. The traditional CFO role gets further burdened by quarterly reporting addressing all compliance. The entire process can be extremely challenging for a company due to business complexity, the continually expanding compliance environment, and the speed at which financial results are expected.
PE firms certainly recognize the importance of the monthly closing process and the need for historical financial statements. However, they may also see these statements as chronological reports that do not provide enough detail to support business decisions. The monthly close often prevents the finance organization from dedicating resources to company-wide initiatives. Furthermore, due to the high-level nature of reports produced by a finance organization, they may sometimes offer little value to business decision makers, particularly those in operations and sales. These departments may often have their "own set of numbers" or strategy produced independently from the finance organization. Consequently, a company's finance organization may become detached from the business decision-making process.
CFO as the Value Creator: CFOs believe they provide value to business. However, many finance organizations may not create additional enterprise value. In fact, if you study the best performing companies, you would find them having
finance organizations with value creation responsibilities across operational activities. PE firms have heightened
awareness of the need to create value. Their ability to raise and invest funds is dependent upon high targeted returns in a relatively short period of time. Furthermore, their business model is no longer based solely on financial engineering and leverage; driving performance improvement has taken on an equally important role. In order to create value, finance needs to provide insight and impact the decisionmaking process. Creating value requires getting the right information to the right people at the right time. Knowledge and good communication skills which the CFO needs to develop to provide forward-looking insights, which can be achieved through best-in-class financial reporting and performance management systems. CFOs create value by ensuring growth is profitable on an EBITDA basis. They look at financial reporting one or two levels below that of the consolidated financial statements. EBITDA-based reports are also prepared for profit centers, cost centers, shared service centers and overhead centers. They detail reports for every line of service, product or project and include pricing, volumes, unit cost and margin information. Although this sounds simple, the determination of what actually drives
revenues, costs and EBITDA is often not easy. Furthermore, traditional allocations, chargebacks and intercompany fees need critical review in the EBITDA world. In partnership with all functional areas, a CFO report details operating results, identifies trends and converts that information into a valuable insight. This process leads to gross margin improvement and the identification and management of cost reduction opportunities.
Capital expenditure (capex) reporting: Another area that can typically be improved to create value. Although PE firms are willing to invest in capex to meet growth targets, such expenditures are highly scrutinized. Prior to an acquisition by a PE firm, many companies make capex decisions based on operating needs and available cash. However, in the value creation process, the entire company has a responsibility to plan current and future capex requirements. The role of finance is to assist in the preparation of cost estimates, revenue benefits, impact on operating costs, and resulting internal rates of return, as well as assessing actual versus
expected benefits.
PMS: Performance Management System, is perhaps the biggest challenge in the value creation process for the CFO to partner with the Board and investors and develop and implement performance metrics. Performance metrics are based on dynamic facts of operation and sales that have an economic impact and are derived from customer, vendor or employee activity. Performance metrics tie companywide activities and performance into a common set of measures. With performance metrics in place, the company can measure its activities and performance against specific and manageable goals. Performance metrics need to be focused and credible. The most valuable metrics are aligned throughout the organization and all stakeholders can understand how their role impacts performance. In order to achieve this, a company must establish a common base of data and processes that combines both financial and nonfinancial information and provides clear and consistent insights. This often requires realigning people, functions and processes from their traditional roles.
The term "heavy lifting" is true and is required by the CFO due to the PE firm's investment horizon - transforming the finance organization from a traditional role to the value creation role which needs to take place quickly. PE
firms may get frustrated with delays if it takes a portfolio company unreasonable time to generate requested data.
However, many portfolio companies, being consumed by the monthly close process, find it difficult to allocate resources to accommodate new reporting requirements of the PE firm.
Furthermore, the finance organization may not fully grasp how critical the new reporting requirements are to the company's operating strategy. Post most PE investments, it becomes imperative to develop and implement reporting and performance management requirements into the existing organization and systems. CFOs would also need third-party consultants to perform the "heavy lifting" to meet this task so that it becomes a seamless addition to the company's monthly close process. CFOs should strive to initiate and complete the "heavy lifting" process as quickly as possible after the change in ownership.
Financial Transformation: This also involves transforming
financial reporting after the change in ownership, change in team structure, expectations. The CFO should ensure
he takes a clear mandate from both the PE and Board. An initial briefing on the mandate, followed by training
sessions and effective organizing and planning, can greatly benefit development and implementation of this
transformation. Also, introducing the finance organization as a business partner to all other functional areas can
have a significant impact. As part of the transformation, it is important to meet with business leaders to define their critical information needs. Business leaders must play a major role in defining objectives of financial reporting and performance management that help create value. It is also an important time to identify other key stakeholders in the transformation process, including knowledge workers and IT. Also, it would not be feasible or desirable to add finance staff to meet new reporting requirements and the CFO should realign within the team for optimum utilization.
With the advent of PE in ownership, reviews of the finance organization and its processes should be conducted by the CFO. It is reasonable to expect that with appropriate process reviews and revisions, efficiencies can be found to expand capacity and free finance resources. During this process, it
is also common to identify and eliminate legacy reports that no longer add value as well as redundant activities. A good example of this is sales reporting performed by both sales and finance organizations. The rationalization of reporting and processes should take place, and any unnecessary or low value activities should be eliminated. This process will free up numerous resources and allow for a critical review of existing data and reporting. Finally, this is an appropriate time to review the effectiveness of reporting systems, use of spreadsheets and various finance functions. There may be further opportunities for automated processes, streamlined procedures or outsourced activities. Revise financial reporting. EBITDA statements have become the new normal for internal reporting. However, merely revising statements on a prospective basis is not sufficient. PE firms need to understand trends and performance against plan. Accordingly, prior months' EBITDA results need to be constructed for both current and prior fiscal years and a current EBITDA budget must be created. Working capital and cash management reporting will take on a higher level of importance in a value creation-focused entity. As most PE acquisitions are funded in part by debt, monthly debt covenant compliance reporting will also be required.
Additionally, monthly capex reporting will become the new normal due to the high level of scrutiny. The monthly reporting pack is generally shared by the PE as part of the transition and gives the CFO the first taste of the PE firm's insatiable appetite for information in the mission to create value. It also becomes the first document that expands monthly reporting well beyond historical financial reporting and the traditional monthly close process. Much of the information that will eventually be required for the monthly reporting pack may not be readily available. Consequently, it is important to commence reporting with well documented information and expand reporting requirements as processes are realigned and necessary data and information becomes reliable. The monthly reporting pack is the first document that is used to provide insights necessary to support the value creation process. Important consideration should be paid to key issues, target exceptions, trends and other forward-looking items. When developing monthly reporting packs, one must identify and include information critical to business leaders in the value creation process. This information will originate in operations, sales, HR and other functional areas of the company. Even sensitive information, such as customer or quality issues, should be included due to their associated risk and cost exposure. The pack may have reporting both in INR and US$ so the appropriate exchange fluctuations and impact need to be assessed and implemented. A good CFO would believe in Fact-Based Performance Reporting; "If you can't measure it, you can't improve on it" is a wellaccepted business principle. To successfully meet companywide strategies and create value, it is important to develop fact-based measurements that include economic impact. It is critical that the entire company focuses on a common set of measurements and targets. These measurements are often referred to as Key Performance Indicators (KPIs). It can be difficult to identify what a company's KPIs should be and then find and assimilate related data. Prior to the advent of PE, promoters may have relied on their experience and knowledge of the company and industry to make business decisions. With a change in strategic direction, key facts, not
intuition, become the norm to support business decisions. Key operating facts exist throughout a company and all lead to an impact on financial statements. Key operating facts in sales and marketing activity can include pricing, sales pipeline facts, closure rates and lead times. Key operating facts in operations can include costs, production or delivery facts, quality issues and scheduling. Employee headcounts and classifications exist in both functional areas and HR. It is very common that key operating facts are not available to the finance organization and that data inconsistencies exist between functional areas of the company. In addition to key operating facts, available data has expanded significantly and exists in many formats. The massive amount of available data has become known as "Big Data." Big Data can be financial or non-financial, internal or external, and it can also come from customers, vendors, operations, sales, employees or advisors. A company can develop a competitive advantage if it carefully selects key data. The data must be timely, relevant and reliable. It also must be comparable and provide the sought after insight. With such a plentiful supply of Big Data, its use needs to be well managed. There should be single data sets within a company and the most reliable and timely sources identified. Careful consideration needs to be given to collecting, migrating, cleansing, transforming, and integrating Big Data into a company's performance metrics. This process invariably leads to the realignment of company employees, processes and systems. Effective performance metrics find their way into the planning and budgeting process.
CFO also leads the Technology Transformation: To meet new reporting requirements, companies often make the mistake of investing in an Information Technology ("IT") solution too soon. IT solutions have an important role in
the value creation process, but the decision to select and implement a system should be made after the requirements
to support the company's new strategy are determined. The first step in transforming the financial reporting and
performance management processes is to identify the data and information required to provide insight and impact
decision-making. It is critical to survey and prepare an inventory of the data, data sources, systems, processes and reporting required, as better use of IT systems, particularly Enterprise Resource Planning ("ERP") and Customer
Relationship Management ("CRM"), can dramatically improve the company's performance. The company should take a balanced approach to transformation, looking at both information needs and business processes. You may also continue using spreadsheets to manually transform financial information and performance management data, to allow for quick delivery of key operating facts with reliability and integrity. After two to three months of working to realign the company, the CFO would be in a better position to evaluate the requirements necessary to support the valuation process. Once data and data sources are known, IT solutions can be considered to automate the process. Additionally, a company may reconfigure or add modules to existing systems. The company may also consider the use of Business Intelligence ("BI") tools, which can be highly effective. Some of the most common BI tools are Oracle, Hyperion, SAP Business Planning and Consolidation, Host Analytics and Adaptive Planning.
To summarize, CFOs are the unsung Heroes for Financial transformation on PE investments but the experience gained during this transformation process prepares CFOs for higher responsibilities in terms of Board positions and Heading the Business with a holistic knowledge and experience of the complete business model.
Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.