Bates Creek Consulting – Page 4 – Helping growth firms succeed

Retrospective Thinking and You!

*Santa Cruz Small Boat Harbor Lighthouse*

McKinsey recently published a survey about whether CFO’s are ready for tomorrow’s demands on finance. For the most part it is not terribly helpful. The additional roles include the “new” fields of risk management and compliance. These tasks have been with us for decades, but today there is a department with the title. My experience with big consulting firms is that they offer good input at a high price. (However, I read everything Tim Koller writes for McKinsey and you should too. I’d classify his insights as great ideas.)

The CFO survey had one question about capital expenditures which caught my attention. Only 30% of the CFO’s agreed that their company “has a formal process to review investments made 3-5 years ago.” This is a big problem as firms that don’t check on their performance don’t learn from their mistakes. Retrospection is hard and I get why you don’t want to do it. Ben Franklin said “Experience keeps a dear school, but fools will learn in no other”. When a management team makes a mistake and doesn’t learn from it then we even less smart than the fools.

I know that everyone cares about the stock price. Stock prices are driven by the return on investment in the projects the management team selects. Poor project selection means poor investment returns and poor stock price performance. Measuring returns informs future investments and identifies opportunities. It creates accountability. It is the difference between taking a class in investing and trading in the stock market for a living. Great investors track their wins and losses and try to learn from both, although the losses are always the most informative.

After being a CFO I took a turn as a hedge fund analyst. About 10 years ago I went to a stock presentation where Coldwater Creek was touting their secondary offering. The plan was to open new units that would generate great returns, earnings and a high stock price. The management team offered up very compelling ROI’s over their first three years of investment in a new unit. I got to ask one question: “how many of these stores have reached their three year anniversary and did they perform similarly to the forecast?” The answer was they had no units that had yet reached the three year life. I wanted a follow up question but the CEO wisely picked on another analyst. Simply put a pro-forma financial model is not the same as actual results. Coldwater Creek never achieved those planned returns and the $32 stock is now worth 2¢.

I worked with a major US bank and was told that the way to promotion was to make a lot of loans fast. When inquired about what happens when they inevitably go bad, I was told that the rotations typically lasted 24 months, and the problems didn’t show up until after you’d left the department. Credit problems were never tracked back to the initial bank officer, just assigned to the executive that then held the portfolio. The difficult job at the bank was in following one of these “fast-trackers” and constantly dealing with a crappy portfolio. This strategy worked until there was a slow down in growth and executives were stuck in the job for 48 months. As Warren Buffett says “ Only when the tide goes out do you discover who’s been swimming naked”.

Recently I heard that the average Silicon Valley CFO lasts 28 months in a job. I’ve never seen a financial analysis on a public company that didn’t go back at least three years if the data is available. The analysis usually go back at least five years and I’ve seen some that go back ten years. We do that to get a sense of how capital has been deployed though the firm’s history. I’ve written here about how hard it is for senior executives to change a business model. Returns on investment are persistent with companies generally moving towards the mean return for the industry. Some of reversion is due to luck evening out, and some of the reversion is due to management teams responding to incentives, both bad and good. If the management team knows that they will be held accountable for capital investments, they have a big incentive to do a better job.

I get that everyone wants to focus on the future and no one wants to poke through past errors. As investors, we are relying on CEO’s and CFO’s to invest the assets of the company wisely. As executives, that means taking a hard look at how capital has been invested, what we did wrong, what we did right and what that teaches us.

* * *

Dr. John Zott is the CFO for Carlson Wireless Technologies, and Principal consultant at Bates Creek Consulting. John is the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University and comments regularly on issues that affect consumer businesses. If you are a former student, colleague or would just like to connect – reach out.

Why Your Staff Quits

Nothing gets done until someone does something. Those someone’s are your staff. Recently a friend quit her job for a new better position closer to home. I couldn’t help but thinking that part of the reason she left was due to how she was treated.

I am not a great “people” person. I am better than Christian Wolff from “The Accountant” as I don’t shoot people and I do have the reputation of being a decent boss. CFO’s in general tend to be quieter than other exec’s, more introspective, we do spend an inordinate amount of time analyzing information, have a large body of technical accounting knowledge and normally emotional intelligence isn’t a prerequisite for the job. Whether you are great at this or not, there are three things I’ve learned that a any senior executive can do to improve their relationships at work. And good relationships lead to lower turnover and higher work satisfaction.

1) Respect your staff. In the movie, Jerry Maguire, Rod Tidwell wanted “quan”. Quan is loosely translated as respect, admiration for skill and the money. Most professionals want their time and skills respected. I hated waiting outside my bosses office for a meeting to begin. I hated getting slide changes for the board meeting 30 minutes before the directors arrived. Respect your people’s efforts. Many senior executives feel more comfortable micro-managing and doing their employees work. Don’t be surprised if your staff doesn’t like it.

2) Talk to your staff. I believe in weekly one on one meetings. The purpose of the meeting is to go over current projects and planning, but you must leave time for the personal. I always started the meeting with a check in and if that was good proceeded to work related issues. Your staff doesn’t leave its humanity at the door when they come to work. Many of my meetings dealt with personal issues, smoothing out work disputes, and understanding more about my staff’s interests, goals and dreams. Unfortunately, a lot of what we do in modern corporations is repetitive and can be a bit dull. If there isn’t a pressing problem, I didn’t cancel the meeting but I’d cut it a little short and we’d focus on mutual interests. If there is a pressing problem the check in was usually cursory. Personal chat is distracting if you are on a deadline.

3) Listen to your staff. If they are dissatisfied it will come out. Usually you are told multiple times before an executive quits. Listening means quieting your voice and engaging with someone else’s story. Listening includes more than just the words. Word selection, intonation, facial expression, eye movements, body position are some of the elements of good listening. Listening takes an effort and your staff can sense when you are putting that effort out and when you aren’t.

Dale Carnegie was right, simply smiling and listening can make a difference in relationships. Often a simple thank you to the staff is all that is required. Turnover is a normal, but lots of turnover occurs because your staff doesn’t feel the quan.

____________________________________________________________

How Financial Metrics Change when Firms Grow

Ichak Adizes consults with firms about managing corporate lifecycles. He states that there are 10 stages of the corporate lifecycle, one pre-start, four growth, four declining stages, and one for organizational death. There is a lot of good material here for a senior executive to consider, but I am just going to focus on the growth side.

Adizes breaks the 4 growth stages into Infancy, Go-Go, Adolescence and Prime. The problems that growth firms face are all the same. It’s always: people, time and money. However, in a growth environment there are different priorities for financial metrics at different times in the cycle.

Firms in Infancy are focused on cash flow. You’ve only got so much cash and so much research and development to do. We define in months our “runway” left by the amount of cash you have divided by burn rate. When you are out of runway, the firm has to be aloft or you are out of business. In Infancy, it is spending on the right things that must be managed by the senior management team. Treat every spending priority as if you had 6 months of cash left. Good employees believe in the vision and are committed. Budgets are check book oriented. Don’t forget the balance sheet because stretching vendors isn’t generating free cash flow!

Go-Go firms are focused on sales growth. That is what makes them fast growers. In this phase the key financial metric is sales. The company wants as much sales as it can get at a good margin. The focus is on selling to firms that pay on time and offer a good margin. Selling a big order to a distributor who is known for slow payment and low margin isn’t as important as selling to five smaller customers for cash up front and a decent gross margin rate. The best hires are able to step in at any level and take care of the customer. Accountability is diffused and procedures are changed on the spot.

Firms that reach Adolescence struggle with balancing the entrepreneurial spirit with professional management. The key people that could do every job in the department now become assigned to one job and they chafe about the lack of “make it happen” attitude. Profits become more important to the company. I’ve had meetings with CEO’s who complain about the lack of expense discipline after hearing story after story from them about how they’d shipped product timely without any thought of costs. Instilling discipline, procedures and process isn’t easy and it has to be balanced against the flexibility that helped the company grow sales quickly. Adizes says this is the most difficult stage for firms and for founders. Budgeting can become a battle rather than a collaboration. Good executives focus on steady process improvements and increasing accountability.

As firms mature into the Prime stage the company balances profit growth, controls and cash flow. Return on investment and risk management become important for the CEO/CFO to manage. The strategy is working, profits and sales are increasing and there is a good balance between entrepreneurial spirit and control. The locus of effort is in longer term planning rather than on day to day operations. Watch for signs of creeping bureaucracy and procedures that kill initiative. New initiatives require taking risk and too much risk management means that the business will stop investing in the future. The senior management team should be setting stretch goals and pushing the company to think outside itself. The focus has to be on the future and maintaining performance.

Eventually if the company is unable to balance return on investment with sales growth and risk management efforts result in too few initiatives taken, the company begins to decline. I’ve followed dozens of mature firms that talk a lot about growth in sales and earnings but don’t grow consistently. Plans are all short term in nature which contribute to the choppy results and don’t create a long term competitive advantage. Often there is increased turnover in the executive ranks, rather than solve the problems we choose to change the players. The focus of the firm is inward, rather than outward. Often sales increases are driven by large increases in invested capital as growth is forced, rather than planned. Discussions about how mergers will help the management team achieve the bonus plan become relevant.

It is easier to stay in the Prime phase than to recover from a fall. To get back to Prime requires leadership by the CEO/senior management team and commitment by the Board to focusing on the profitable core of the business. Firms that fail to face previous mistakes and poor capital allocations can struggle for years.

Dr. John Zott is the CFO for Carlson Wireless Technologies, and Principal consultant at Bates Creek Consulting. John is the chair of the Careers Committee at FEI Silicon Valley, a senior adjunct professor at Golden Gate University andcomments regularly on issues that affect consumer businesses. If you are a former student, colleague or would just like to connect – reach out.

Becoming a more rational executive, five good techniques

I teach behavioral finance. That is the study of how people make financial decisions and how those decisions differ from the perfectly rational. We are currently in the part of the semester that deals with corporations and how they vary from perfect rationality.

I teach behavioral finance. This is the study of how people make financial decisions and how those decisions differ from the perfectly rational. We are currently in the part of the semester that deals with corporations and how they vary from perfect rationality.

Anyone who has spent any time in business knows that business life is not perfectly rational. There are big ego’s, incorrect incentives, limited analytical resources and group think. The hierarchical nature of large institutions also increases the likelihood that the organization won’t respond timely, which is also irrational.

When we do the class I collect stories of corporate irrationality from the students. There are many. We also brainstorm techniques for staying rational at work.

Here are five techniques for CFO’s to add rationality to decision making. Three of these approaches can be attempted prior to embarking on the strategy, the last two are ways to are for after you’ve taken a path and it isn’t working.

1) What is the base rate for success on this strategy? Why should our efforts be any different than the base rate?

This technique is basically applying your circumstances to historical base rate stats, which is called Bayesian inference. A common application I’ve used this technique is estimating the likelihood of success for a new product. The base rate for product failure in the market is between 40-90%. For example, we’ve come up with a product concept that we feel is good, but faces several technical hurdles to reach the market. The chances of product success is then a function of the chances of success on each of the two steps: finishing the product and obtaining success in the market. Identifying the risks improves the planning process.

2) Conduct a pre-mortem. This is a concept that Gary Klein wrote about in the HBR, September 2007. The idea is to imagine that your project or strategy has failed spectacularly and then ask the question “Why did this happen?”. Hindsight is a powerful tool and it changes your perspective. Problems that were lurking in your subconscious get a chance to be aired. The resulting list of “reasons” for failure become improvements to the plan. Identifying timing, resource or scope issues prior to beginning the project results in cheaper and easier fixes. CFO’s are often the department of “no”. This technique allows you to get the whole team to think critically about a plan without being the wet blanket.

3) Stay intellectually and emotionally distant enough to use your judgement. Optimism and confidence in business are great. Being a part of a team that is conquering a market is a peak experience but that experience can blind CFO’s to reality. Denise Shull writes about using emotion to make better decisions. CFO’s and CEO’s, if good, live both inside the organization and outside. The outside perspective means that you are aware of the challenges within the business and secondly you can look at the business with a clear mind. Founders are, in general, terrible at this, but professional management can’t be.

Here are two techniques for after you are involved in a project that you think might be going bad.

4) If we knew then what we know now, would we still go ahead? This is a way of focusing on the sunk cost question. A full commitment to an ok strategy is better than a weak commitment to a great strategy. I’ve been in a lot of projects where significant investments of time and energy have been invested and then we find out a key fact that makes the project a lot less attractive. However, because we are all fully committed we ignore when key facts have changed.

5) “What would happen if somebody took us over, got rid of us — what would the new guy do?” asked Andy Grove of Gordon Moore in 1985, and this question is relevant for every senior executive. Firms get into ruts. Sometimes the answer is clear but because of institutional momentum management teams never think about the obvious choice.

5 Customer Perspective Questions for CFO’s

Great CEO’s and CFO’s see both the inside and outside of the firm. The inside perspective is natural, it is the default mode in corporate life. The outside viewpoint is harder but it offers a wealth of insights. Although there are many outside perspectives, a crucial one is the customer’s viewpoint. When I work with a company I am vitally interested on how customers perceive the product and the company. Here are five questions you can ask yourself about the customer’s perspective.

1) Do you respect the customer? The customer perspective doesn’t come easy to finance executives. I’ve heard senior executives refer to their customer base as stupid and cheap, and similar to cows. Although you don’t have to use your company’s products to be a good executive, it helps.

2) Do you get customer feedback? There is a saying “the best fertilizer is a farmers’ footsteps.” Great executives get in the field and see how customers react to the product. I hate business travel, but there is no substitution for getting great customer feedback. Although CFO’s can’t spend the same amount of time the CEO spends talking to customers it is an important part of the executive role. I know a lot of marketing execs swear by big data analytics. I love big data but stories drive passion and illuminate the data.

3) Are your customers thrilled or merely satisfied? Are we promising one thing and delivering another? Often the internal “story” we tell in the office is not connected to the reality in the field. My rule of thumb is to never give a customer something they don’t want and won’t pay for. Additional features increase price without increasing value. Engineering teams will design the ultimate product, management egos get wrapped up in featurism, and pretty soon that great little software tool bloats up. Be clear about what you are promising, make sure it is what the customer wants and then deliver on that commitment.

4) Are your operations streamlined to deliver on the promise you’ve made to the customer? The CFO has a key role in identifying where efforts (and costs) should be placed. Sometimes you centralize (and sometimes decentralize) but figuring out the best tradeoff in location, cost and service can increase profits significantly.

5) Is your business model congruent with what you’ve learned? Although the CEO owns the business model, the CFO is key in developing the strategic plan. I’ve always drafted the agenda for strategic planning sessions, including identifying the key strategic questions. Having a handle on the customer allows a CFO to ask the right questions, and shape the strategy so that the intersection between your company and the customer results in profits.

Alan Kay said that “A change in perspective is worth 80 IQ points.” The fastest way to be smarter about a problem is to change your perspective.

CFO thoughts on Business Models

Fortune magazine reports that Warren Buffett stated in 1988, “With few exceptions, when a manager with a reputation for brilliance tackles a business with a reputation for poor fundamental economics, it is the reputation of the business that remains intact.” Bad business models often result in poor fundamental economics. Business models are hard to get right, and often very hard to change.

A 2014 survey of CFO’s asked about reporting and earnings quality. The Financial Analyst Journal reported the (Dichev, Graham, Harvey and Rajgopal) study in their Jan/Feb 2016 edition. The survey results are full of interesting details including the estimate of 1 in 5 financial statements being “cooked” with material (10% or better) adjustments. That information is worthwhile and it is bolstered by a list of ways CFO’s can tell there is a disconnect between reality and the financial statements. The survey also identified that a goal of financial reporting was about “conveying the long-run view of the profitability…of a bundle of assets”. As interesting as this is, I’d like to focus on another aspect of the article, the sense by the CFO’s of what drives earnings quality.

The survey inquired about factors that determine earnings quality – both internal and external. The top factor was the business model of the company. The other inputs included external factors such as the industry, accounting standards and macroeconomic conditions. Internal factors included internal controls and the aforementioned business model. Clearly, management teams are accountable for internal controls, but the argument for business model is not as certain.

Management teams are hired- they don’t create the business. They are brought in for their leadership, management, talent, knowledge and skills. Consequently, much of the business model is defined before the management team starts. Good business models require a good design in the beginning and careful nurturing. As markets change, business models grow obsolete and no longer fit their markets. Watching video has increased steadily in the last 20 years and yet the local Blockbuster is now a Dollar Tree.

I once joined a company that was earning <1% operating profits, and had no growth. In one year sales were up 10+%, and operating margins increased to 4%. In the next several years, we were never able to get operating profits much above 7%. In the years after I left, operating margins averaged less than 1%, until finally it went bankrupt.

The managers who followed me were a mix, some weak, some strong, some were tactical, some were strategic. When they took the position, they were confident about generating great results, but in the end none were able to solve the business model puzzle. Earnings were invested in a series of new initiatives which never resolved the core problem. Eventually weak profitability and lousy returns on capital resulted in a steady turnover in CEO’s and eventually it was sold to private equity who split out the good assets and bankrupted the rest.

This firm clearly had a business model issue. Flat market share, low returns on capital, little ability to innovate or compete in new segments. Low earnings quality is an outcome of the business model, and tinkering is not going fix it. So what do you do with a business that has poor fundamental economic performance? Here are a couple of strategies that can work.

One way is to get a break, either a technological change, industry change or strategic option which creates an opportunity that allows the firm to innovate. Richard Rummelt discusses this approach in his book “Good Strategy / Bad Strategy”. Blockbuster knew that digital streaming would hurt their business, but couldn’t come up with a strategy that was effective. Netflix, which was in the mail order DVD business, however, did. Searching, selecting and creating this opportunity takes time, resources and patience.

Another option is to pare the business down to the profitable core, and then build up from there. The focus here is on increasing the return on invested capital. A good business invests in projects that deliver a better than market return and prunes functions and divisions that do not. Will the business get smaller? Yes, it will, but the remaining business will provide a foundation for growth.

Both of these strategies have significant downsides for management. Few business leaders are strong enough or are far-sighted enough to risk the company on a technological change. Boards don’t like risk taking and the bigger the business the bigger the inertia. Paring down a business can often mean several years of declining sales. Even if you are adding to profits by subtracting a poorly performing operations, there will be concern by the Board, by investors and even by the management team. CEO and senior executive compensation is highly correlated with company size and declining company size means declining compensation. This is a lot of headwind, which explains why there are so many firms stuck in this state.

The bottom line is that it is a whole lot easier to keep a business model working well, then to fix it after it is broken.

Dichev, I., Graham, J., Harvey, C. R., & Rajgopal, S. (2016). The misrepresentation of earnings. Financial Analysts Journal, 72(1), 22-35. Retrieved from http://0-search.proquest.com.library.ggu.edu/docview/1762049797?accountid=25283

Risk Mitigation for CFO’s

In my earlier post, I noted that converting uncertainty to known-unknowns requires thinking hard about the potential things that can go wrong and having a good risk identification search process. I broke risk down into true risks, which are insurable at some level (known frequency and severity) and uncertainty, which could be hard uncertainty (can’t be known at a reasonable cost) and soft uncertainty (can be known relatively cost effectively).

Many firms do a poor job of searching for problems. I have found several styles of management teams that struggle dealing with risk.

Insular management teams are prone to very large areas of soft uncertainty. Home grown executives are often dealing with problems for the first time. Unaware of problems at other firms they repeat mistakes long solved elsewhere. A diverse management team of backgrounds, industry and experience is just a better management team.
Management teams that are dominated by a single executive also tend to underestimate risks. Although I’ve worked with some great CEO’s, no one executive can reasonably see or know all the questions. If the CEO calls all the shots, over time, management teams will let the CEO handle all the thinking too.
Firms with long term winning track records can begin to ignore risks as success begets complacency in the company culture. Company culture can be a great strength, but when the culture becomes too dominate, it blinds management to problems. Andy Grove suggested that only the paranoid survive, which is good advice. However, when you win a lot, it is tough to remain paranoid.
An executive team that is highly incentivized by the stock price (usually with options) tends to stay focused only on the positive news, and to only invest in strategies that appear to have a direct correlation with option value (usually growth initiatives). Stock options skew management priorities because the risk is one-sided. If the stock price fails to increase or the company goes bankrupt the options are worthless. So for the option holder, ignoring the risk of a blow-up makes sense, they only get paid if the stock goes up. In these firms, it can be hard to get management focus on the known issues, much less invest in searching for unknown potential problems.

CFO’s have to assess risk. To do this, we must examine the business, the environment and the management team.

Managing Risks

When I try to manage risks, I start with a good scan of what could go wrong. Some of these we insure, some of these we cannot. Frank Knight broke risk into two categories, uncertainty and real risk. Real risk is calculable, it has a frequency and a severity. Uncertainty has neither.

Donald Rumsfield’s comments on knowledge can be related to risks. Rumsfield stated that there are known knowns or things we know we know. These risks have a known frequency and severity and are generally insurable and controllable.

There are known unknowns, which are questions which we have, but which we don’t have an answer. These are complicated risks that can’t fully be insured because the frequency is low, or the severity is incalculable. These risks can still be managed.

Finally, there are unknown-unknowns, where we are not aware of the questions or the answers. Risks that are unknown can’t be managed or insured. This category is the same as Knightian uncertainty.

The risks that make business crack up are generally unknown-unknowns and are often a surprise to management and investors. Risk management for the CFO becomes a process of handling the various real risks and trying to better understand Knightian uncertainty.

Bad and unusual events that we were not aware of are sometimes referred to as black swan events. Nassim Taleb defined black swan events as a surprise with a major impact. The thing about black swan events is that it may be a surprise to you, but it doesn’t mean mean that the event wasn’t known by others. That is true also for Knightian uncertainty. A larger knowledge base decreases uncertainty and unknown unknowns can be reduced by learning.

I therefore break uncertainty into two slices, hard and soft. Soft uncertainty are issues that could be learned with a reasonable investment in diligence and research. Hard uncertainty can’t be. The trick is to convert soft uncertainty into complicated risks, where management, insurance and reporting processes can be brought to limit losses. Hard uncertainty remains retained risk.

“Risk comes from not knowing what you’re doing.” – Warren Buffett

Converting uncertainty into something that can be managed requires an open mind and a sense of paranoia. CFO’s who think risk management is an annual lunch with the broker are going to find themselves surprised by events.

Some thoughts on Risk Management

CFO’s are usually tasked with risk management. Often that means being in charge of the insurance renewal negotiations. Basically this consists of an annual conversation with your broker on new policies that have been developed to help eliminate some new exposure which you weren’t aware of, and by the way, at a price that you can’t afford. Generally, the broker buys lunch, which is the best part of the transaction.

CFO’s that define risk management as simply buying insurance make a mistake. Corporate risk management has to include problems that can severely damage or destroy a business but are basically un-insurable. The types of problems we’ve seen with credit cards and hacking are a CEO’s nightmare. A single instance can cause irreparable damage to sales and the value of the business. How does a modern risk manager or CFO deal with these types of “all-in” risks?

Risk is usually defined as a function of frequency and severity. Frank Knight, back in the 1920s, argued that there are two realms of risks. Simple risks, which have a known frequency and severity, and uncertainty which is not and cannot be known. Pretty much if an insurance company writes a policy, you know they’ve got a frequency distribution and a good handle on severity. After all, insurance companies aren’t stupid. The big risks, however, remain in the uncertainty realm and those risks remain uninsured and uninsurable. Knight also noted that entrepreneurs generate profit by dealing with uncertainty and not risk.

Since we can’t know the future, business have to learn to deal with both types of Knightian risk. Dealing with known frequency and severity risks can be difficult, but the biggest challenge are in uncertainty or unknown distribution risks. Donald Rumsfield said: “The message is that there are no “knowns.” There are things we know that we know. There are known unknowns. That is to say there are things that we now know we don’t know. But there are also unknown unknowns. There are things we do not know we don’t know.”

Paraphrasing this into risk speak, we have insurance that covers the simple risks we know. Complicated risks that we are aware of but aren’t well known can only be partially covered by insurance. In these cases we manage the risks, putting in control processes, training and contingency plans to limit the occurrences and severity. Unknown risks by definition are retained and aren’t managed. Without a reporting processes, problems start, grow and can overwhelm a firm. This is true uncertainty.

What makes a risk truly an unknown-unknown? Does it imply that no one nowhere knows the risk? It does not. It simply means that the current management team is unaware of the risk. Nassim Taleb has a great story about a turkey who during its life considers the farmer a benefactor. The week before Thanksgiving the turkey finds out the plan, and imagines it an unforeseen and unknowable event. It might have been for the turkey, but it is not for the farmer.

The risks that will hurt your business are generally the ones that you aren’t managing. Integrated risk management is about pulling together efforts that manage exposure, control what can be controlled and insuring what can be insured. A good integrated risk management plan includes bringing the management team together to focus on the key risks, whether they involve credit cards, hacking. off-shore oil wells or workers compensation.

What a Good CFO does…

A good CFO helps the CEO run the company. The CEO’s job is to set a vision, hire management, build a culture and make sure the firm has enough capital. A CFO partners with the CEO by buying into the vision and taking on responsibilities for managing capital and building the management team and culture.

CFO Magazine a couple of years ago tried to define the difference between a good CFO and a great one. They basically concluded that great CFO’s understood the customers, used data and analysis to distill problems down to simple words that the team can use to run the business. I like to think that having a CFO in the mix helps all parts of the management team get better, by bringing in new concepts and ways of thinking about problems.

The basic functions of a CFO revolve around reporting & compliance, treasury functions and strategic planning duties. The main difference between an accounting manager or controller and a CFO is a matter of perspective and approach. A CFO focuses on the longer term, and often on issues affecting people outside the business.

Reporting and compliance are often handled by a Controller who manages the monthly close, and maybe the annual audit. The Controllers focus is on this month and this quarter. The CFO should be a decent accountant, but they add value by asking the right questions. A CFO helps define the key indicators (both internally and externally) that need to be tracked, managed and communicated. A good CFO thinks through the business model so that when it shows up on the financial statements, the data is not just right, but the accounting policy is sound.

Treasury functions (borrowing, investing) require thinking out a couple of years, and an investor/outsider perspective. Figuring out cash needs, matching borrowing with investments, estimating the debt vs equity ratio are relatively simple calculations. The art is in the estimates. Managing the relationships with the bankers, lawyers, investors and advisors requires understanding the needs of the firm as the outside advisors. If you don’t trust your CFO to handle this responsibility, you don’t have a CFO.

The CFO is a leader on the executive team in implementing strategy and a planning process. Converting from a simple annual budget to a strategic plan and multi-year budget requires someone to run the process. Coordinating projects, assessing investments and developing workable plans is a balancing act frequented by “no’s”. Good CFO’s build relationships across the organization to make those no’s understandable and the yes’s more likely to be successful.

A lot of planning includes thinking about the world outside the firm: customers, the environment and what is going on in the industry. Firms are often buffeted by economic storms that could be foreseen, for those who would look. If the CFO is not facing outward, it is unlikely any other executive will be either.

CFO’s have to be thinking out a year or two and sometimes longer. The quarterly earnings focus that the street demands is a false choice. Great performances can’t be generated quarter after quarter (and year after year) if you are focused on closing transactions in the last two weeks of a quarter.

Capital allocation and investing in technology and capabilities requires thinking about how things will look in the future. I’ve signed dozens (maybe hundreds) of leases with 20+ year life. If you can’t think further ahead than next month you can’t make long term investments.

I am sure that there are great CFO’s and lousy CFO’s. What separates them is the perspectives they bring and the actions they take.