Time for CFOs to step up
Timothy Koller and Jonathan Peacock
As investors home in on business fundamentals and credible accounting, the CFO’s traditional oversight of planning and performance takes on new urgency.
The chief ﬁnancial officer’s job has become more complex in recent years as mergers and acquisitions, financial structuring, andmanaging relations with investors and analysts have demanded increasing amounts of time and attention. At the same time, the potential value that the CFO adds in a more traditional role—as guardian and leader of good planning and performance management—has lapsed into neglect. Today, as business fundamentals and credible accounting become the new touchstones by which investors judge corporatequality, many companies would benefit if their CFOs gave renewed attention to helping chief executive officers understand the performance of their businesses and to evaluating critical strategic decisions.
There is no question that mergers, financial dealings, and investor relations are important. Mergers can add significant value under the right circumstances, as can innovative financing. Goodcommunications with investors and analysts can help companies avoid unnecessary market volatility and ensure that they get credit for the strategies they pursue. But for most companies, shareholder value comes from internally generated growth, through new products or services, new business, or cost and capital efficiencies. One characteristic of today’s business climate is a seemingly endless stream ofadvice about shortcuts that promise to create value without much hard work. In just the past few years, executives have been exposed to value-based management (VBM); economic value added (EVA), also known as economic profit; the
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balanced scorecard; cash flow return oninvestment (CFROI); and a flurry of other performance measures. More recently, intangibles such as brands and knowledge have captured attention. Most of these ideas are good, and largely common sense, but not one of them is perfect. And certainly none of them is a magic bullet that would make improving a company’s performance easy. Instead, the hard work of designing and implementing a successful planningand performance-management approach involves developing a method that works for your company. Even the most sophisticated financial measures will fail if they aren’t adapted to your situation; a less sophisticated approach can create significant value if it is tailored to your industry and your company’s needs. With that in mind, here are four principles that CFOs can rely on to keepthemselves—and their companies—on track.
1. Understand how your company creates value
It is surprising how many executives don’t know exactly how their business units create value (by such measures as profits and cash flow). In our research we found that half the retailers in the United States don’t earn their cost of capital. Yet managers at many of these companies demonstrate an obsession with growth thatwill destroy value until their managers can figure out how to improve their returns on capital. In the pharmaceuticals industry, for example, where the leading companies manage to earn after-tax returns on capital in excess of 30 percent, growth has a much larger impact on value than do increasing returns. Yet many pharmaceuticals companies don’t effectively measure or manage the value of theirresearch, development, and product launch activities. This process need not be overly complex, but it must give management transparency on cash flow and on risk and returns on capital invested. In the absence of authoritative planning leadership, it is easy for executives to focus on the wrong value creation measures. At one company, top managers agreed to vote on performance measures. Product...