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PEST Analysis

See Also:

SWOT Analysis
Porter’s 5 Forces of Competition

PEST Analysis

Certain changes to the business environment can either help you or hurt you. Using the PEST Analysis, you can anticipate factors that can be used to your advantage or that you can solve before they affect your company negatively.

Political Factors: Government policies regulate trade markets and other business environments. Political factors such as trade and safety regulations, taxes, and employment all affect a business.

Economic Factors: Factors such as interest rates, stability, taxes, and inflation affect a company’s activity. Following economic trends is important for the company because without preparation, a company may be unprepared for the sudden changes.

Socio-Cultural Factors: By examining the socio-cultural aspects of the environment, you can study the market’s customer demographic, lifestyle choices, disputes or limitations, and general knowledge. This is best used to model campaigns and strategies to appeal to the customers within that environment. Education is also a major socio-cultural factor because it molds the mindset of attitude of millennials.

Technological Factors: Changes in technology provide windows of opportunity. With updated technological processes, a company is more prone to innovation, growth of a company, and may even be able to re-target to the younger generation. Technology is always changing, and therefore a company should project how and when to adapt to the change.

PEST Analysis

PEST vs. PESTEL

Some may encourage that the additional “-EL” is necessary to include in this analysis. For this wiki, we will use the term “PEST.” However, if you were curious, the “E” in “PESTEL” stands for Environment and how a company affects it. This means climate, pollution/recycling, and laws surrounding energy usage.  The “L” stands for Legal, which deals with factors such as the laws pertaining to business (employment and safety, patents, discrimination, etc).

How to do a PEST Analysis

Similar to the SWOT Analysis, you should gather all related data pertaining to your environment (political, economic, socio-cultural, and technological). Then, you determine which of the factors serve as an opportunity and which factors are a threat to the company. Keep in mind that this analysis is a decision-making approach, and no action should be taken until the planning is complete. Once you’ve gathered all relevant data and determine the opportunities/threats, the company is then ready to make a change or decision. Download the free External Analysis whitepaper to overcome obstacles and be prepared to react to external forces.

PEST Analysis

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PEST Analysis

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Collection Effectiveness Index (CEI)

See Also:

CEI vs. DSO
Key Performance Indicators (KPI’s)
How Does a CFO Bring Value to a Company?
5 Stages of Business Grief

Collection Effectiveness Index (CEI)

The Collection Effective Index, also known as CEI, is a calculation of a company’s ability to retrieve their accounts receivable from customers. CEI measures the amount collected during a time period to the amount of receivables in the same time period. In comparison, the collection effectiveness index is slightly more accurate than daily sales outstanding (DSO) because of the time period. A company’s CEI can be calculated for any amount of time, small or large. Conversely, DSO is less accurate with shorter time periods, which is why DSO is calculated every 3 to 6 months.

The Collection Effectiveness Index Formula:

Collection Effectiveness Index

The formula consists of the sum of beginning receivables and monthly credit sales, less ending total receivables. Then, divide that by the sum of beginning receivables and monthly credit sales, less ending current receivables. The value is then multiplied by 100 to get a percentage, and if a CEI percentage is close to or equals to 100%, then that means that the collection of accounts receivables from customers was most effective.

(Are you look for more ways to improve your cash flow? Click here for the free complete checklist guide to improve your cash flow!)

CEI and Your Business

The collection effectiveness index is one of the most useful tools a company can use to monitor the business financials. It measures the speed of converting accounts receivables to closed accounts, which then indicates new methods or procedures one can use to retrieve accounts receivables even more. If the CEI percentage decreases, then that’s a key performance indicator that the company needs to put in place in policies or investigate the departments in more detail.

How to increase a company’s CEI

Among other ways to reduce accounts receivable, the collection effectiveness index alerts when and how to change the process of retrieving those accounts. By monitoring cash in a company more frequently, financial leaders will notice a pattern and are more inclined to make a change quicker. Changing your policy from checking 3 times a year to 6 or 8 times a year, and the results that come from it, will show a substantial difference in a company.

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Normalized Earnings

See Also:

Key Performance Indicators (KPI’s)
Collection Effectiveness Index (CEI)
How Does a CFO Bring Value to a Company?

Multiple of Earnings

Normalized Earnings

Normalized Earnings are adjustments made to the income statement in preparation to show potential buyers of the company.  These adjustments eliminate expenses that are not usually incurred for the production of the business. To show a more realistic return on investment, the expenses that are normalized should not appear on the future buyer’s income statement.

Different Types of Normalized Earnings

There are multiple types of special expenses that are unusual on a typical income statement. For now, let’s categorize them into two types of normalized earnings – Type A and Type B.

Type A: Non-Recurring Gains and/or Losses

The goal of “normalizing earnings” is to provide prospective buyers a typical income statement so they know what to expect. Expenses such as a lawsuit, non-operating assets, and other abnormal items that occur once are considered expenses that can be eliminated when normalizing earnings.

Type B: Discretionary Expenses

Certain expenses may not be recorded at fair market value price. These expenses are adjusted so the buyer of a company will not assume these expenses are incurred regularly. If these expenses are included, the current company owners should specify that these expenses or earnings are not generating/generated by business. Examples include vacation homes, car rentals, start-up costs, and unreasonably high bonuses.

(Want to learn how to measure your company’s key performance indicators for free? Get it here!)

Normalized Earnings Example

Laura Johnson is the CEO and founder of X company, and now wants to sell it. Her current business generated over $2 million last year, according to her income statement.

Normalized Earnings

Type A: Laura experienced a lawsuit and lost $250,000. Because this was one-time event, the lawsuit expense can be removed for adjustment purposes.

Type B: Laura’s sales team had a sales contest to boost revenue for the year 15%, and two salespeople gained extremely high bonuses totaling to a $100,000 additional salary.

By normalizing these earnings, EBITDA increases by $350,000, earnings that the buyer can potentially make without those extra costs.

 SCFO- Lead Magnet for KPI Discovery Cheatsheet

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Continuous Accounting: The New Age of Accounting

See Also:

Reducing Your Cash Conversion Cycle
Key Performance Indicators (KPI’s)
Accounting Principles 1, 2, and 3
Accounting Principles 5, 6, and 7

Continuous Accounting: The New Age of Accounting

Continuous Accounting is the new age of accounting. It provides a more efficient way to review financial performance in a real-time automated process, and a trustworthy, repeatable accounting cycle to forecast future results. It also gives the financial department a larger role in strategy and planning.

The Old Model: Record-to-Report (R2R) Accounting

The traditional model consists of a linear record-to-report process for accounting. In order to complete a record-keeping process, a company must report certain tasks and responsibilities pertaining to the company’s financials. These are expected to be completed by the end of the period, which can last anywhere from two weeks to two months, and the data is stored and managed in a large computer processor. Disadvantages of this process are 1) the data accumulated over a large period of time have a greater chance for error with unreconciled transactions, 2) inaccuracy and misrepresentation, 3) takes up too much time and loses effectiveness of team.

The New ModelFinancial Strategies with Cloud-Based Technology

Managers and financial leaders cannot afford to wait a month to two months for reports to be processed, which is what bookkeepers tend to do. Continuous accounting changes the prolonging process from period-end to a day-to-day basis. The cloud platform is capable of recognizing and verifying information constantly and repeatedly, thus enabling it to be “continuous.”  This evenly distributes work rather than accumulating large amounts of tasks over time. Continuous accounting is an organized alternative to the old model of record-to-report accounting.

Shifting Business to the Continuous Accounting Platform

In the past, bookkeepers would record with accumulated reports, which would process a month at a time at least. With the matching principle, the company matches the expenses that are incurred during the same period the revenue is recognized (or the time the service was performed). Instead of recording in batches, the accounting system was modified to recording as they occurred. Now, the next progression is to continuously reconcile accounts and analyze detail. In order to do this, companies would have to automate their systems, because bank statements and other records would have to be linked and reconciled daily.

The New Age of Accounting

Advantages of Continuous Accounting

1. Continuous Accounting processes financial information faster than before.

Certain companies depend on a faster cash conversion cycle, in which case this technology would be useful. Instead of reviewing financial information every month or so, continuous accounting will complete the processes day-by-day. The processing of financial information will be quicker,and key performance indicators will become more apparent and easier to fix. This allows financial leaders to eliminate risk and take action proactively and defensively.

2. Automated systems improve the productivity of the accounting departments.

Increased automation should result in the benefit of improved productivity. This reduces costs because taking the manual systems, rather than automatically through continuous accounting, and applying them everyday would be cost-prohibitive.

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Disadvantages of Continuous Accounting

1. Adapting the finance departments to a new way of accounting.

Implementing change is always a challenge, especially when done in a department that has been trained for 10, 20, 3o years on how to properly perform accounting. Larger companies would benefit from continuous accounting more than smaller companies, where new, younger, more adaptable people work. However, the disadvantage of switching from traditional accounting to this new automated technology is that the larger companies have employees that have worked as an accountant for 25+ years and aren’t as adaptable.

2. Financial statements may not be as accurate. 

Instead of waiting a couple of weeks before submitting invoices or reports, continuous accounting processes the information right away. This leaves little time to adjust and organize data. By using continuous accounting, the financial leader succumbs to having financial statements 90% accurate rather than the expected 100%.

How Continuous Accounting Affects the Future of Finance

Technology itself is changing finance departments globally. Continuous Accounting is just the start of new automation processes that pertain to large sources of data. Technology such as Continuous Accounting establishes a precedent for timely, cost-effective, and/or high-quality improvements for business.

Know Your Economics (on blog)-2

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How Does a CFO Bring Value to a Company?

See also:
Role of a CFO
5 Ways a CFO Adds Value
EBITDA Definition

How Does a CFO Bring Value to a Company?

Most CEOs don’t understand how a CFO brings value to their company. They see CFOs as overhead rather than income-producers. CEOs typically see the role of a CFO as a CPA or a regular accountant role. In actuality, the CFO is responsible as a financial leader to determine whether the company is successful or unsuccessful. A strong CFO knows how to add value to an organization. There are numerous tactics such as reviewing tax information or analyzing every financial statement involved with the company, but from a strategic standpoint, it’s very simple how a CFO brings value to a company.

According to our 5 Ways a CFO Adds Value article, the CFO of a company should be able to perform in five ways: 1) growing the company faster, 2) improving profitability, 3) improve cash flow, 4) obtain increased leverage from banks, and 5) provide leadership and direction throughout the company. A good way to measure profits and cash flow is to follow your bottom line — your EBITDA.

So why EBITDA? Why not simply check cash flow or sales? Investors prefer to use EBITDA because EBITDA allows bankers to compare and monitor performance over time. EBITDA is the best measurement for the value of a company.

How Much Value Should a CFO Add?

How much should a CFO be able to contribute, and what is the reciprocating value proposition? Having worked with hundreds of companies over the past 25 years, I’ve noticed that there hasn’t been a solid financial leader set in place initially. The ultimate goals for a CFO are to improve profits, manage risk, and free up cash flow.

Let’s assume that EBITDA equals net income. This is so we do not miscalculate interest, taxes, depreciation, and amortization. If a CFO is hired to improve a business, this means that the CFO should configure a way to optimize cash flow and costs to the point of increasing EBITDA by 1-2%.  It is a general expectation that the CFO should improve cash flow and profits by this percentage. Improving business right away by 5-10%, for instance, as a CFO is much more difficult than expecting 1-2%, which is why that is the general rule of thumb.

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The CFO Value Proposition

The EBITDA improved in a company is equivalent to the salary the CFO is paid. If a company generates $20 million in sales, that company would typically pay the CFO $200,000-400,000, depending on the size of the company. From this theory, CFOs should be able to pay for themselves the first year by identifying ways to free up profits and cash flow.

Revenue ($20,000,000) x Value of CFO (.02) = CFO Salary ($400,000)

                                        underline
                                         Value Proposition

The same concept applies for larger companies that generate $100-200 million and pay the CFOs a salary of $1-2 million. CFOs of larger companies are typically paid a higher salary than middle-market or smaller companies. On the other hand, start-ups typically don’t pay their CFOs until they have generated a certain amount of revenue. Most companies under $10 million don’t even have a CFO, because value proposition is nonexistent.

How does the CFO Drive Business?

How do we equate the value of a CFO to the value of a business? The answer is simple: Most companies sell 3-5 times EBITDA. 

If a CFO comes into a $20 million company and increases profits by $200,000, the CFO creates anywhere from $600,000 to $1 million worth of value within the first year.  A CFO driving EBITDA not only frees up that cash flow, but sets a precedent by increasing the value of the company for the future. The investment of $200,000 in a CFO is worth the payback of  a $600,000 to $1 million constant return.

For example, a client I worked with hired a CFO, and within the first year, he generated an increase in business of 72%. The second year, he added another 20% on top of the previous year’s improvement. After 3 or 4 years, the CFO was then in charge of expanding the company and finding new opportunities for growth, such as opening another location for the business.

So how does a CFO add value? It’s a mutual relationship. The CFO of a company separates from title of “overhead,” and evolves into the financial leader for a company.

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The Role of the CFO (Chief Financial Officer)

See Also:

How Does a CFO Bring Value to a Company?

The Role of the CFO (Chief Financial Officer)

The role of the CFO (Chief Financial Officer) has been changing over the past twenty years. Originally, the role of the CFO revolved around producing and analyzing the financial statements. However, because of the computerization of the accounting function the need for accounting skills in performing the roles and responsibilities of a CFO diminished.Though the job description of a CFO (Chief Financial Officer) remains broad the tasks comprising that function fall into four distinct roles.

The Strategist CFO

The first role of the CFO is to be a strategist to the CEO. The traditional definition of success for a chief financial officer was reporting the numbers, managing the financial function and being reactive to events as they unfold. In today’s fast paced business environment producing financial reports and information is no longer enough.

CFO’s in the twenty-first century must be able to “peak around corners”. They must be able to apply critical thinking skills, along with financial acumen, to the long term goals of the organization.

The CFO as a Leader

The second role of the CFO hand in hand with the first one; that is one of a leader implementing the strategies of the company. It is no longer sufficient for a CFO to sit back and analyze the effort of others. The chief financial officer (CFO) of today must take ownership of the financial results of the organization and senior management team.

The chief financial officer of today must be responsible for providing leadership to other senior management team members, including the CEO. The CFO’s role can sometimes force them to make the tough calls that others in the organization don’t or can’t make. Occasionally, this can mean the difference between success and failure.

The CFO as a Team Leader

The third role of the CFO is that of a team leader to other employees both inside and outside of the financial function. Not only will a coach call plays for a team, they are also responsible for getting the highest results out of the talent on their team.

An aspiring and successful coach will produce superior results by finding the strengths of their team members and obtaining a higher level of performance than the individuals might achieve on their own. The role of the CFO (Chief FinancialOfficer) is to bring together a diverse group of talented individuals to achieve superior financial performance.

The CFO with Third Parties

Last, but not least, the role of the CFO is that of a diplomat to third parties. People outside of the company look to senior management team for inspiration and confidence in the company’s ability to perform. In almost every case the financial viability of the company is vouched for by the CFO.

The CFO’s role becomes that of the “face” of the company’s sustainability to customers, vendors and bankers. Often these third parties look to the CFO for the unvarnished truth regarding the financial viability of the company to deliver on it’s brand promise.

Today’s Role of the CFO

In today’s fast paced environment the role of the CFO is extremely fluid. One day the CFO might be developing a compensation plan for employees and the next day taking their bankers on a tour of the facilities. Consequently, to be a successful CFO in the future you must be a more multi-functional executive with financial skills.

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The 5 Stages of Business Grief

In her 1969 book On Death and Dying, Elisabeth Kubler-Ross outlines the five stages of grief individuals experience when faced with catastrophic personal loss. The five stages are:

  • Denial
  • Anger
  • Bargaining
  • Depression
  • Acceptance

In one form or another, businesses too experience these five stages when faced with crisis or catastrophe. These 5 stages of business grief are related to loss. For a business, this can be loss of income, customers or the enterprise as a whole.

While an individual must progress through the grief cycle at their own pace, it’s important for businesses to arrive at the final stage of acceptance as soon as possible so that corrective action can be taken before things get too far out of hand. The following is an illustration of how each of the 5 stages of business grief might play out in a company.

Stage 1 – Denial

The first stage of business grief is denial. The business owner may try to shut out reality or create an alternate reality that is preferable. They may try to convince themselves that the situation is just temporary or that the crisis won’t affect them or their industry. Some may even hire consultants to validate the status quo rather than deal with the problem.

Stage 2 – Anger

The delayed reaction caused by denial gives rise to feelings of anger. At this stage of business grief, the business owner may start to play the blame game. Why are greedy suppliers flooding the market and driving down prices? Why are my customers so disloyal and squeezing me on my pricing? Why can’t my people just do their jobs right? Some owners may turn the blame inward and chastise themselves for not seeing the crisis coming.

Stage 3 – Bargaining/Rationalization

At this stage of business grief, business owners will often reach out to third parties to weather the storm. Some will ask vendors to extend payment terms. Some will negotiate with bankers for cushion on debt covenants or to extend lines of credit. Many daydream about the big contract they’re about to win that will turn things around.

Stage 4 – Depression/Despair

Oftentimes, bargaining during a crisis doesn’t solve the problem. Vendors are often over-extended to their suppliers, banks are having to tighten up on controls and customers are hesitant to take on new projects due to uncertainty. When the reality of the situation dawns, owners may fall into despair. After all, what’s the point in soldiering on if the underlying cause is out of your control?

Stage 5 – Acceptance

Most business owners are made of pretty sturdy stuff and will not allow themselves to wallow in self-pity for long. Consequently, they will make peace with the threat and begin to develop a strategy to deal with it. How? By focusing on what’s working and eliminating what isn’t. By transferring resources to more profitable products and eliminating those products that kill margins. By hugging their best customers and firing the problem ones. By unleashing the creativity in their best employees and purging the ranks of bad hires.

Crisis and catastrophe are inevitable in a business. The key is to recognize the crisis and resolve the 5 stages of business grief quickly to get back on track.

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