Be World Class — January 2017

This post involves Financial Management. An effective CFO can be very helpful to the entrepreneur by helping the company develop characteristics of a world class financial organization. These characteristics include, providing business analysis, focus on overall business performance, development of innovative solutions to business problems, ad-hoc analysis, and reduction of costs. This post will concentrate on developing a framework through which some or all of these characteristics can be developed by the CFO with the CEO’s approval.

The first decision to make is whether to operate as a centralized or decentralized finance organization. A decentralized finance organization is close to the customer in matters involving sales, billing, and inventory control. The CFO is very engaged in managing customer interaction and provides analyses of issues such as budgeting, performance evaluation, pricing and new markets/products. This structure, which we believe is normally better for a small business, provides flesxibility innovation, service and motivation while aligning the interest of the business and customer.

A centralized finance organization tends to be focused on cost reduction and automation. Very often it benefits form economies of scale due to centralized activities such as payroll, accounts payable, financial statement preparation, and cash management. Benefits from this approach include top down internal controls, uniformity, expertise, best practices, and cost control. In our view, this approach works only for certain types of small businesses. These businesses typically operate in multiple states, are highly regulated, and have relatively large transaction sizes. Finance companies are a good example.

Once this decision is made, the CFO must devise the appropriate finance organization. To implement a world class finance organization approach, the CEO’s vision and strategy must be articulated to the entire firm. We view the CEO’s vision as defining the attributes by which the firm will be known. For example, innovative, easy to do business with, or a winning culture. The strategy entails how the vision is to be achieved through an integrated set of tactics. Data gathered through the finance organization must be used to measure of the CEO’s vision and strategy by utilization of financial measures, analysis of the internal business process, metrics regarding the customer, and the learning and growth of employees. As problems are identified, corrective action is taken.

In traditionally capital intensive businesses financial analysis can do a very good job at measuring performance and identifying issues. Such analysis includes measurement of issues regarding liquidity, asset turnover, financial and operating leverage, and returns generated on the company’s investment and to its shareholders.

Up to a point, these measurements also work well in the knowledge economy. However, we believe traditional financial analysis must be complemented by human capital measurements. Such an effort entails treating human capital like a cash flow that is quantified to show a return on the efforts of the workforce. This is particularly applicable when the workforce has significant input as to the tasks they pursue.

A means to calculate a return on the investment in human capital starts by defining human capital as the entire workforce rather than specific individuals. The CFO must construct a configuration that measures per person workforce costs. These costs include employee related costs such as compensation, benefits, training, health care, and cost of turnover. The return on human capital is then calculated by dividing net operating profit by the workforce expense (which represents human capital). This ratio must be tracked over time and, where possible, benchmarked against industry leaders. If the firm falls short, corrective action is necessary.

Corrective action should begin with an analysis of the strategy, tactics, and analytical framework. Any necessary adjustment must be implemented. Once this is accomplished, there should be an analysis of workforce matters such as size, composition by task, and workflow. The appropriate adjustments should then be pursued where required.

An effective CFO can be very helpful to the entrepreneur by helping the company develop characteristics of a world class financial organization. These characteristics include, providing business analysis, focus on overall business performance, development of innovative solutions to business problems, ad-hoc analysis, and reduction of costs.

Capitol CFO Solutions serves clients in Maryland, Virginia, and Washington, D.C. Please contact us for a free consultation.