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.
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)
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.