To understand value creation, this presentation will provide the audience with an understanding of structuring debt - including using derivatives to hedge interest risk and stock dilution. Optimizing liquidity and funding availability to allow for flexibility in mergers/acquisitions and corporate restructuring. Discover financial flexibility through long-term financial planning. Understand dynamics of research and the related investor and stock price behavior.
- Learn financial strategies and obtain practical tools to create value through funding (public or private funding)
- Understand how to use restructuring options effectively
- Gain knowledge on the practical application of risk management
Hello, welcome. My name is Louis Fanzini. I’m a Senior Finance Executive with extensive experience in leading financial strategy. Today, we’ll discuss value creation, and that value is created through capital raising, risk management, and restructuring strategies.
To understand value creation, this presentation will provide you with an understanding of structuring debt to create value through funding, whether it’s public or private funding, including using derivatives to hedge industry and stock dilution, optimizing liquidity and funding availability. This will allow for flexibility in mergers, acquisitions, and corporate restructurings, as well as an overview of those corporate restructurings and how to use it effectively. Finally, you will gain knowledge on the practical application of risk management.
So what’s our agenda for today? First, I wanted to give you a little bit of a an overview of what a CFO does. Next, we’ll discuss the options available for the CFO to create value. Then, we’ll discuss different sources of capital and how to raise those funds, an overview of corporate restructuring, a practical application of risk management, and finally, we’ll pull it all together and discuss how value creation translates to shareholder value.
So what is the role of the CFO? The CFO, the Chief Financial Officer, occupies the top financial position within an organization, and is responsible for a broad range of activities including accounting, fundraising, risk management, acquisitions, as well as strategic planning.
Today, we’re going to discuss value creation, and how the CFO is expected to be the Chief Adviser to the CEO, or Chief Executive Officer, and position the organization for long term growth. The CFO must have strong knowledge of accounting issues, cash flows, investor relations, tax planning, and financial reporting. This knowledge should be coupled with the ability to communicate easy with the entire senior management team, and board of directors, as well as bankers and auditors.
Today, we’re going to speak about the CFOs role in forming the strategic direction of the businesses, as well as understand current and potential risks to which each business is subjected to, and taking steps to mitigate those risks. More specifically, the CFO role includes planning. This involves the formulation of strategic direction of the business, as well as tactical plans, budgeting systems, and performance metrics. Operations. This requires the direct oversight of a number of departments, as well as coordinating the operation of those departments. It can also include the selection, purchase, and subsequent integration of acquired businesses.
Financial information. This involves a compilation of financial information into financial statements, and the presentation of this information to various internal and external recipients. The CFO also is responsible for risk management. This involves understanding the current and potential risks to which the business is subjected to, as well as taking steps to mitigate those risks. Finally, financing. This involves monitoring projected cash balances, and arranging for either additional financing or investment options, depending on the amount of expected cash balances.
Let’s discuss some options available to the CFO to create value. As background controllers and accountants generally focus on past results and manage data produced financial statements, while the CFO also looks to the future and helps lead the organization. Well, how does the CFO do this? By monitoring key performance indicators using dashboard reporting, as well as monitoring cash. The CFO also looks at the future by developing an annual budget, rolling forecast, and potentially, a three to five year strategic operating plan.
In order to maximize shareholder value as we see here, there are three main strategies for driving profitability in a company. First, revenue growth. Next, operating margin. Finally, capital efficiency. Since the value of a company and its shares are based on the net present value of all future cash flows, that value can be either increased or decreased by changes in cash flow, as well as changes in the discount rate. Since the company has little influence over discount rates such as [indistinct], its managers focus on investing capital effectively to generate more cash flow with less risk. A CFO will know what steps are required to develop long term exit strategies, as well as succession plans that fit the company’s goals and circumstances. They help to prepare a company by having defensible financials and a logical strategy before an interested parties are built.
So looking to the slide, what are some of the levers a CFO can pull? We typically look for capital efficient, profitable growth. Capital efficiency is the ratio between dollar expenses incurred by a company and dollars that are spent to make product or service. This could also be explained as the return on capital employed or the ratio between earnings before interest and tax over capital employed. This generally shows how efficiently a company is deploying its cash and its operation.
Now, why is this important? Well, with a constriction in higher scrutiny in venture and limited partner, capital markets, this is generally the metric to look at because the more efficiently capital is used to produce a product and service, the better chance the company has for approaching profitability. Profitability equals returns for investors.
Well, how is this achieved? We’ll discuss a little more in the upcoming slides. For example, increasing profits, that’s something that is fundamental, how to grow revenues and also reduce costs. What about new products, increasing sales prices, adding to marketing budgets? The discipline cost management process is also extremely important. Without working capital, that’s a metric that should always be closely reviewed. Smart inventory management, continuous review of payment terms and receivable terms will help with cash flow and ensure optimal working capital.
Let’s break this down in a little bit more detail. Growing revenue. For any goods and services businesses, sales revenue can be improved through the strategic sales, volume increasing, or sales price inflation. Increasing sales volume. To do this, a company would want to retain its current customers, reduce churn, and keep them away from competitors in order to maintain market share. The company would also attempt to attract new customers through referrals from existing customers, marketing promotions, and also adding new products and servicing offerings. Company can also raise the sales price. So if you have a current product, company may consider raising those if they haven’t been raising in a while, or gradual price increases throughout several months, quarters, or years in order to achieve revenue growth. Company can also offer new products, new advanced processes, new advanced qualities within a product, new features and price them at higher ranges. Ideally, your business can combine both higher volume and higher prices to significantly increase revenue.
Besides maximizing sales, a business must identify feasible approaches to cost reductions, which lead to optimal operating margins. While a company should strive to reduce all of his expenses, cost of goods sold, selling general and administrative expenses, they’re usually the largest categories that need to be efficiently managed and minimize. Talk a bit about cost of goods sold. So when a company builds a good relationship with its suppliers, it could possibly negotiate or renegotiate with suppliers to reduce material prices or receive discounts on larger orders. Company can also form a long term agreement with each supplier to secure its material source of pricing.
Many companies use automation in their manufacturing process to increase efficiency in production. This automation not only reduces labor and material costs, but also improves the quality and precision of products, and will largely reduce defective and return rates. Return management is something that’s also important. It’s the process by which the activities associated with returns and reverse logistics are managed. It’s an important factor in cost reduction because a good return management process helps the company manage the product flow efficiently, as well as identifying ways to reduce undesired returns by customers.
Selling general and administrative expenses, SGNA. That’s usually one of the largest expenses in a company. Therefore, being able to minimize them will help the company achieve an optimal operating margin. The company should tightly control its marking budget when planning for next year spending. They should also carefully manage payroll and overhead expenses by evaluating periodically and cutting down unnecessary labor and other costs. Shipping cost is also directly associated with product sales returns. As a result, good return management will help reduce the cost of goods sold, as well as logistical costs.
Capital efficiency. That’s the ratio between the dollar expenses incurred by a company and the dollars that are spent to make a product or service. Capital efficiency reflects how efficiently a company is deploying its cash and operations. It includes working capital. Within working capital, you’d want to discuss property plan and equipment. To achieve high capital efficiency, company would first want to achieve a high return on assets or ROA. That measures the company’s net income generated by its total assets. Over time, the company might also shift to developing its proprietary technology, which is a system application or tool owned by a company that provides competitive advantage to the owner. The company can then profit from utilizing this asset or licensing the technology to other companies. Proprietary technology is an optimal asset to possess. That’s because it increases capital efficiency to a great extent.
What about inventory? Well, inventory is a major component of a company’s total assets. The company would always want to increase its inventory turnover. Inventory turnover of course means net sales divided by the average inventory. A higher inventory turnover rate means that more revenues are generated given the amount of inventory. Increasing inventory also reduces holding costs, consisting of storage, space, rent, utilities, theft, and other expenses. It can be achieved by effectively managing inventory. That involves constant monitoring and controlling of inventory orders, stocks, returns, or obsolete items within your warehouse. Besides inventory, buying efficiency can be greatly improved by using the just in time system. Costs are only incurred when the inventory goes out and the new orders are being placed, which allows for companies to minimize costs associated with keeping and discarding excess inventory.
There are many different sources of capital, each with its own requirements and investment goals. They fall into two main categories: debt financing, which essentially means borrowing money and repaying you with interest, and equity financing, where the money is invested in your business in exchange for part ownership. Let’s talk equity capital that’s otherwise known as net worth or book value. This represents a company’s assets minus its liabilities. Some businesses are funded entirely with equity capital in the form of cash invested by the shareholders or owners of a company. This is the favorite form of capital for most businesses because they don’t have to pay it back, but it can be extraordinarily expensive, and can require massive amounts of work to grow an enterprise that’s been funded. One example of this is Microsoft. Microsoft, however, generates high enough returns to justify a pure equity capital structure.
What about debt capital? A large part of the cash management task is ensuring that there’s sufficient cash on hand to fund company operations while some of the cash might come from sales and turn investments. It’s also entirely possible that the CFO must raise cash from outside parties. A major source of funding is debt. This type of capital is money that is given as a loan, so to speak, to the business with the understanding that it must be paid back at a predetermined date. The owner of the capital typically bank and bondholders agrees to accept interest payments in exchange for you using their cash.
Think of interest expense as the cost of renting the capital to expand your business. It’s often known as the cost of capital. According to the SBA, about 80% of US small businesses rely on credit, at least in part, to fund their operations. Debt can be the easiest way to expand for most young businesses, because it’s relatively easy to access and is understood by the average American worker, thanks to widespread homeownership. So give you an example, the profit for a business owner is the difference between the return on capital and the cost of capital. For example, profit of 5% or $5,000 wouldn’t have existed without the debt capital borrowed by the business if you borrowed $100,000 and pay 10% interest yet earned 15% after tax.
The final type of funding we wanted to discuss was preferred equity. Now, preferred equity is a general term used to describe any class of securities, be it stock, limited liability units, limited partnership interest that have higher priority for distributions of a company’s cash flow other than common equity. So there’s a higher priority for distributions of the company’s cash flow or profits than common equity. The main difference between preferred and common is that preferred gives no voting rights to any of the shareholders, while common stock does. Common stockholders are less than line when it comes to company assets, which usually means they’ll be paid out after creditors, bondholders, and preferred shareholders.
Raise all this capital we’ve been talking about. Typically, companies go on a fundraising roadshow. That’s a series of meetings with investors with a specific intention of raising funds. During a roadshow, the presentation team will likely be accompanied by an investment banker who has arranged all of the meetings with the potential investors. These investors are likely to be fund managers who are responsible for investing the funds, which was they have been entrusted by their clients. Any fund manager could potentially invest a very large amount in the company. Each one deserves a private presentation, and that’s what typically happens.
When a company plans to raise money through an investment banker, the banker typically issued a notification to their contracts throughout the company. If any investors are interested, the banker schedules time with them so that the presentation team can visit several investors. Typically, this happens in a row in one city, and move on to the next city and presented the next cluster of interested parties. In some cities where there are larger numbers of prospective investors, say New York or Chicago, the presentation team might schedule an entire trip just to that one city and then continue with their roadshow to other cities and follow them.
The CFO helps business owners identify and target potential companies for an acquisition or merger. Many companies regularly consider M&A as part of their strategic initiatives. CFOs can fill a critical role in the success of these initiatives by being a strategic growth advisor to the CEO. For companies who are selling, raising capital, or acquiring smaller businesses for growth, the CFO plays a vital role at every stage in the deal process. For example, the CFO will oversee merger or acquisition transition, help integrate multiple accounting departments, establish or integrate accounting systems, evaluate existing procedures, perform due diligence on a potential M&A company to ensure the integrity of its valuation, and also create a comprehensive integration plan for when a deal does close.
The most effective CFOs have the ability to build consensus, anticipate change, and manage surprises. As a problem solver with an innate desire to learn, most CFOs understand what initiatives are needed to help the organization move forward with this strategic vision. The CFO will attend to the future of the business and think strategically about the company’s future growth and prosperity.
Finally, we wanted to discuss risk management. Risk can be defined as an event that interferes with the ability of a business to achieve its objectives. That definition merely implies that a company’s planned growth rate could decline as a result of a risk event. In reality, some risks are so massive that they could potentially throw a business into bankruptcy, which is a far greater problem than a mere reduction in the rate of growth. The corporate planning function should have a detailed knowledge of a company’s risk profile. That is because they need to incorporate the variability and size of potential risks into future plans.
Since the CFO is usually responsible for corporate planning, this person should not only be covered instead of the major risks, but also detailed knowledge of the associated plans to mitigate those risks. The CFO should periodically review these risks, if only to identify the most likely ones to cause trouble for the business. So for proactive and discipline risk management practices, the company should review risks that are required to build your business, but only if those risks fit your strategy and can be understood and manage. The risks do not expose the enterprise to any significant single loss event. For example, do not bet the company on any single acquisition, any single business, or any single product.
Finally, any risk taken should not harm your copy your corporate brand. The types of risks to which your business is subjected will vary considerably. Since each risk is based on factors as geography, industry, product type, employers relations, and so forth, the risk mix is unique to every business. I’ll give you an example. A mining company is subjected to the risk of a local shut down by people who object to local pollution. A business in the apparel industry may face a customer revolt over the working conditions of employees at its foreign clothing factory. All risks are different, but must be assessed individually as it pertains to the company that the CFO is managing.
There’s so many factors that influence shareholder value. It can be very difficult to accurately attribute the causes and its rise or fall. Managers of businesses constantly speak of generating shareholder value, but often it’s more of a soundbite than an actual practice. Due to a host of complications, including executive compensation, principal agent issues, the primacy of shareholder value can sometimes be called into question. Businesses are influenced by many outside forces. The impact of management versus external factors can be very hard to measure.
One thing a CFO and its company must do is maintain a two way line of communication with the investment community. These capabilities can be translated into the following investor relation goals. First is to maintain an active marketing in a company stock, so the investors want to have confidence that they can easily move in and out of the stock positions. That’s only possible if there’s a large inactive market for a company stock. Investors also want to see a fair valuation. By adopting an understandable story for a business and managing expectation around that story, company should be able to achieve a reasonable stock price valuation. Finally, the company must enhance its ability to cost effectively raise capital as needed. There should be investors who are sufficiently cognizant of a company’s capabilities, as well as their results that would be willing to invest in your company at a reasonable share price. By knowing what options are available, a CFO can create value that fits company strategy, and puts the company in a position for consistent future growth.
I hope you enjoy this presentation. I will provide a deeper dive into some of these value creation concepts at a later session. Thank you.
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