The Essential CFO | Bruce Nolop

With the accounting and controls side of the house now in order, a new CFO
profile has emerged: a strategic, operationally oriented finance executive who can
serve as the business partner to the CEO.

Chapter 1
Articulating a Strategic Plan - Every company has one and the CFO can play an
important role in helping to articulate a strategic plan and analyze its effectiveness
Business Objectives - The CFO defines and confirms the business objectives that
form the building blocks for creating shareholder value through a top-down
overview (describing the company today and predicting what it will look like):
Systematic review of the companys historical performance
Position against competition
Companys strategies
Strategic Theme - CFO should establish a shorthand communication for the way
that the company is going to create value. (ex. Develop Superior products, expand
in emerging markets, lower cost structure, exploit economies of scale, maximize
free cash flow).
Long-Term Financial Model - CFO has to translate the business objective into
long-term financial projections, converting the strategic framework into a tangible
financial plan.

Modeling Methodologies: more oriented toward finance rather than

accounting perspectives, which means that it relies more on mathematical
formulas - such as historical and expected revenue growth rates - and focus
more on cash flow assumptions and metrics

Valuation Measures: determine the amount and the sources of shareholder

value creation over the planning horizon.
The most common market values is the multiple of EBITDA in order to
determine the companys enterprise value:
(EBITDA x Multiple) +/- net financial position = EV

Strategic Metrics: Cost reduction, emerging markets, innovation, technology,

market leadership, cross-selling, superior products.

Total Shareholder Return - is the ultimate measure of the stakeholder value

created per share common stock.
TSR = Annual % growth rate in the stock price + Value of dividends received
(including any shares distributed through a spin off).

Capital Allocation Strategies - CFO can help for allocating capital among
Capital Expenditures, Dividend Payments, Share Repurchases, and Acquisitions.
Acquisition Strategies - Acquisitions should not be pursued as financial
transactions, but rather as ways to accomplish business objectives more quickly,
more cheaply, or with less risk. CFO can articulate the types of acquisitions that
the company will be targeting:
Consolidations: M&A in a mature and fragmented industry (to strengthen
market consolidation and expand products)
Bolt-ons: in order to obtain cost synergies or to save time and expenses.
Platforms: to obtain targets knowhow, brand name, customer base.
Transformations: in order to shifts from a business that is in decline.

Chapter 2
Consistency and Transparency CFO play an integral role in achieving
alignment, emphasizing consistency and transparency in the companys
messaging.
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Consistent Communications: repetition of key message points in order to

reinforce the companys commitment.
Transparent Communications: through metrics and the flow of
information.
Stakeholder Communications: not only with investor, but also with
external and internal constituencies

Incentive Compensation Programs are important tools in achieving

alignment around the strategic plan objectives. CFO can play a role in
recommending the metrics used for determining bonuses and other incentive
compensation.
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Incentive Compensation Metrics: CFO establishes a mix metrics that are

either quantitative or/and qualitative
Absolute or Relative Performance

Investor Alignment CFO should manage expectation. CFO establish

credibility with investors and cultivate a reputation for delivering on their
promise.
Analyst Relations central to the CFOs goal of achieving alignment and
communicate with the investors.
Investor Presentations CFO play a primary role
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Investor Conferences: direct communications with investors sponsored by

brokerage firms and often hosted by a sell side analyst (employed by
brokerage firms to communicate with investors) who covers the company.

Advantages: Broad Dissemination, Small Group Meetings, Competitor

Presentations, Investor Feedback).
Group Meetings: meet informally with a group of investors who have
been convened by a sell side analyst.
Investor Day: showcase the management team and to provide updated of
the strategic objectives. In contrast to investor conferences, an investor
day is sponsored by the company itself.
Road Show: often sponsored by sell side analyst all over the most
important cities in the world.
Virtual Road Shows: conference call.

Media Relations CFO play an active role especially in the strategic and
financial topics.

Ernst & Youngs Media Relations: 10 Tips for the CFO:

1- Prepare for the unexpected
2- Have clear goals for an interview
3- Keep it simple
4- Do not be afraid to dig in
5- Ask for feedback
6- Get to know journalist and their agendas
7- Prepare for everyday situations not a crisis
8- Make the time for media training
9- Work in tandem with the corporate communications team
10Recalibrate tour measure of successful media relations
Media Training - can provide helpful tips
- Stick to Message Points: prevent rambling
- Do not repeat a Leading Question
- Avoid Extraneous Subjects: avoid personal opinion
- Keep It Simple: audience less sophisticated
- Be Self Confident

Chapter 3
Enterprise Risk Management Systematic approach in order to identify,
monitor, and mitigate risk exposures.
Implementation of ERM Company proceed along the following path:
1- Identify Risk Incidents - For Banks and financial services companies, this
process is focus on asset portfolio risks and liquidity risks. For nonfinancial companies, implementing ERM has meant not only a broadening

of the risks being monitored, but also a shift in emphasis toward business
risks that heretofore have not been a priority for internal audit reviews.
2- Quantify The Exposures Many companies evaluate the risks through a
heat map that ranks the risks according to a 1 to 5 scale on two
dimensions: the probability of an occurrence and the magnitude of the
potential impact.
3- Major Exposurese
a. Disruptive Technologies: to reduce risk is important to innovate
continuously and perhaps to lead the cannibalization of the existing
ways of doing business.
b. Data Security: concern over cyber security.
c. Reputation and Brand Image: the rapid dissemination of
information through electronic media makes this threat all the more
real and alarming.
d. Government Regulation
e. Natural Disasters: create uncertainty that devastate companys
future prospects.
f. Long Tail Events: risks that a remote probability based on normal
standard deviations, but that can have catastrophic effects.
Deloittes 10 Fatal Faws of Conventional Risk Management:
Counting on false assumptions
Failing to exercise vigilance
Ignoring velocity and momentum
Failing to make the key connections and manage
complexity
Failing to imagine failure relying on unverified sources
of information
Maintaining inadequate margins of safety
Focusing exclusively on the short term
Failing to take enough of the right risks
Lack of operational discipline
4- Mitigation Strategies after identifying their risk exposures, companies
then determine which risks should be retained through purchasing thirdparty insurance or by taking action steps to prevent an occurrence or to
reduce the potential magnitude of loss.
o Preventing an Occurrence: technology investments, management
procedures, training and education.
o Mitigating an Occurrence: Insurance policies, disaster recovery
plans, backup arrangements (alternative supplier)

5- Rewarded Vs Unrewarded Risks the primary purpose of ERM is to

understand a companys risk exposures and to adopt risk strategies
coherent.
The unrewarded risks do not provide any upside to the company and
typically should be managed to minimize their potential impact. In
contrast, rewarded risks can be managed to realize their potential upside.
CFOs Role in ERM:
a. Linkage to Strategy Articulate the strategic plan.
b. Financial Organization Encourage the free flow of relevant
information through both formal and informal communication
channels.
c. External Contacts Identifying potential threats and opportunities.
d. Mitigation Expenses Analyze the purchase of insurance or
investments in risk avoidance technologies.
e. Investor Interest They want to understand a companys risk
management strategies.

Chapter 4
Estimating the Cost of Capital building block for capital allocations, providing
consistency across the potential investment alternatives and facilitating
comparisons among alternatives that have differing time horizons and risk
profiles. It also provides a basis for comparing reinvestments in the business
through capital expenditures or acquisitions versus the return of cash to
stakeholders through dividends.
WACC Formula
L: % of debt leverage in the companys market capitalization
R: Risk-free of interest (measured by the 10 year Treasury rate
C: Pre-tax of debt
M: Markets expectation for equity market returns (typically assumed to be 67% over the
Risk-free rate of interest
B: Correlation of its stock price with the market
T: Companys marginal tax-free
Cost of Debt = C x [1-T]
Cost of Equity = B x [M-R] + R
WACC = L x [Cost of Debt] + [1-L] x [Cost of Equity]

Betas: vary among industries and companies, reflecting differences in

their sensitivity to economic and financial environment. A Beta over 1.00
means that a stock moves more than the market, indicating greater
market risk, while less than 1.00 means that a stock moves less than the
market and indicating lower market risk. Sources for betas (Bloomberg,
FactSet, Thomson Reuters).
Unlevered Betas: In adjusting for differences in debt leverage CFOs
should compute an unlevered beta and then relever the beta to reflect
the target capital structure for the private company.
o Unlevered Beta: Beta/[1+Debt/Equity)x[1-Tax Rate]
o Relevered Beta: UB x [1+(Debt/Equity)x(1-Tax Rate)]

Hurdle Rates - the minimum acceptable rate of return, often abbreviated

MARR, or hurdle rate is the minimum rate of return on a project a manager or
company is willing to accept before starting a project, given its risk and the
opportunity cost of forgoing other projects.
Risk Premiums - the difference between the expected return of a particular
financial activity and the interest rate risk-free. []

Chapter Five
Prioritizing Capital Investments The CFO typically manages a companys
process for determining how much funding should be allocated to capital
expenditures over a planning period and then prioritizing the potential
investments within the companys funding constraints. In theory, a company
should invest in all the projects whose returns exceed its rick-adjusted cost of
capital. However, capital budgeting is usually subject to practical constraints
that limit how much can and should be reinvested in the business.
Cash Flow Projections The process for allocating capital begins with the
cash flow projections. The CFO estimates the cash flow from operations over
the planning period, with a particular focus on the budget year.
Cash Flow from operations = Net Income + Non Cash Expenses (Depreciation
of fixed assets, amortization of intangibles, deferral of taxes) Net working
Capital requirements for inventories, receivables, prepaid expenses, and
paypables.
Free Cash Flow = Cash Flow from operations Capital expenditures

The available free cash flow indicates the amount of cash that is available for
discretionary used as dividends, share repurchases, and acquisitions.
Investment Budget Then the CFO develop an investment budget that will
reflect an estimate of the total cash funding for discretionary projects.
Increasing the Investment Budget CFOs have several potential levers for
increasing the amount of capital that can be allocated
to discretionary investments in the business. These
levers fall into 4 categories:
1- Increasing cash flow from operations Accelerate
revenue growth, implement cost reduction, reduce
working capital requirements
2- Reduce other capital allocations Dividend increases, share repurchases
3- Use surplus cash
4- Obtain incremental financing
Evaluating Projects CFO should view potential projects through the lens of
the companys strategic plan and ensure that the project evaluations focus on
strategic as well as financial considerations.
Return on Investment Criteria:
- Net Present Value (NPV) sum of the present values (PVs) of incoming
and outgoing cash flows over a period of time.
- Internal Rate of Return (IRR) is a rate of return used in capital
budgeting to measure and compare the profitability of investments.
- Payback shows the amount of time (expressed in years) it take to get
the companys cash investment back.

Chapter Six
Considering Dividends and Repurchases CFO evaluate the alternative
uses of capital to pay dividends to shareholders or to repurchase the
companys shares. The alternatives for returning cash to shareholders include:
- Initiating a regular dividend payment
- Increasing an existing dividend rate
- Paying a one-time special dividend
- Repurchasing shares via tender offer
- Repurchasing shares in the open market
Dividend Policy Alternatives to determine the company value proposition:
1- Not Paying a Dividend great flexibility
2- Paying a Token Dividend signals to investors

3- Maintaining a Constant Dividend avoids disappointing

investors
4- Achieving Consistent Growth with solid balance sheet
and reinforces an image of stability
5- Targeting a Payout Ratio increase dividend percentage proportionate to
its growth
6- Offering an Attractive Yield dividends are fundamental to the
companys strategy for delivering total return to its shareholders and is
associated with a less volatile stock
Dividend Policy Consideration
- Long-Term Commitment: most public companies want to maintain their
existing dividend rate, at minimum. A reduction can result dramatically
negative impact on the stock price. In the case of private companies
shareholders also have expectations.
- Management Signal: maintaining or increasing the dividend rate not only
provides a tangible return to investors, but also signals managements
confidence in the companys future outlook.
- Dividend Discount Model: is a method of valuing a company's stock price
based on the theory that its stock is worth the sum of all of its future
dividend payments, discounted back to their present value.
Special Dividends A special dividend is a payment made by a company to
its shareholders that the company declares to be separate from the typical
recurring dividend cycle, if any, for the company. Typically, special dividends
are distributed if a company has exceptionally strong earnings that it wishes to
distribute to shareholders or if it is making changes to its financial structure,
such as debt ratio.
Dividend Declarations require approval from the board of directors. If there
is a shift in the companys dividend policy, CFOs usually will prepare analytical
materials that support the proposed action.
Repurchase Considerations A program by which a company buys back its
own shares from the marketplace, reducing the number of outstanding shares.
Share repurchase is usually an indication that the company's management
thinks the shares are undervalued. The company can buy shares directly from
the market or offer its shareholder the option to tender their shares directly to
the company at a fixed price.
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Flexible Payments: most significant advantage compared with dividends.

EPS Growth Rate: can accelerate the earnings per share growth rate due
to the reduction in shares outstanding. This higher growth rate can have
a positive impact on the companys P/E multiple.
Positive Signal: to investors.

Debt Leverage Target: share repurchase can be a vehicle for rebalancing

companys capital structure.