Often as CFO consultants we come upon business situations that just don’t add up. We look at the mess someone got himself or herself into and we just shake our heads in disbelief that they didn’t take time to fully evaluate a project based on proper financial considerations. There were little or no financial goals, projections or analysis conducted before they went forward.
Probing deeper we look for answers to some basic questions:
- Was there a written plan or budget on how much you were expecting to spend?
- What amounts and types of revenue increases were you projecting?
- How long did you plan on funding the project before you realized expected results?
- What financial milestones were put in place to determine success?
- Was there cash flow planning?
Often the answers are “we saw a huge market opportunity and figured the numbers work themselves out with increases in revenues,” or “you can’t accurately project all the unknowns,” and a favorite – “this is a once in a lifetime opportunity and we had to act quickly.” What they’re really saying is “the numbers don’t matter.”
Often the source of the problem is an overly optimistic owner or CEO who doesn’t want anyone getting in the way of their deal. This especially goes for the “bean counters” who are often viewed as narrow minded, non-risk takers.
So here is the CFO challenge: We’re not involved in the upfront planning process but are financially responsible for making it work.
As CFOs, we’re not “sales and marketing people,” so when it comes to creating revenue projections based on market penetration and competitive analysis, that’s not our expertise.
What we can do as CFOs is create a financial model that considers costs, cash flow and expected profitability based on various “what if” revenue scenarios provided by the sales and marketing people.
These various “what if” scenarios allow management to measure and consider the impact of such things as missing revenue projections by 10 percent, having a 5 percent cost overrun on construction or a 12 percent increase in the cost of labor.
We understand you can’t project every detail exactly and that is not the goal of the planning process. The idea is to look at a range of assumptions, estimate the financial impact based on the model and determine if the returns justify the risk.
I was recently asked to help an owner of an insurance agency evaluate the purchase of another agency. He had an idea of what he was willing to pay but was not sure how he could determine the cash flow impact and feel comfortable before he moved forward.
We laid out a 12-month projection, looked at various revenue estimates and, after a study of various assumptions, he determined the risk was too high for the return and backed out of the deal. The analysis showed that if he went forward there was little room for error and cash flow would have been extremely tight.
The CFO can be a valued resource when it comes to evaluating all the financial “nuts and bolts” and not just the return on investment (ROI). ROI alone can be misleading if cash-flow timing is not considered. An annual ROI of 13 percent sounds great on a $200,000 investment, but you may have to cash flow the $200,000 for 11 months before you receive the entire return in month 12.
Can this planning process be complicated? It doesn’t have to be if you’re working with someone who understands all the financial dynamics. Good CFOs not only understand finance they also understand business and can be a valuable strategic partner to an owner or CEO when evaluating the overall impact of a proposed project or investment.
So if you’re looking at an investment or project and you’re thinking “the numbers don’t matter” you may be heading for a mess!