Category: CFO Page 2 of 4

Being a CFO. Some of my thoughts and observations after years of being a CFO

Business Partnership

On June 14, 2016

I often describe to people how I have fixed broken teams at places I have worked at by increasing or implementing business partnership. Every once and a while, I get a request to explain what I think good business partnership between Finance and other functions is and what I do to make sure it happens.

First, the whole reason why a good partnership is important is because it amplifies the ability of all of the people involved in the partnership and is a key element in the art of strategy. Strategy, as I have discussed earlier in my blog, is the art of winning (https://mgpotter.com/what-does-it-mean-to-be-a-strategic-cfo/). To go back to the master of strategy, Miyomoto Musashi and his Book of Five Rings, I will show how the importance of people is a main focus of strategy.

From the Earth scroll, there are two important passages:

“The master carpenter learns the structural pattern for building a tower or a temple and knows the construction plans for palaces and fortresses. He builds houses by making use of people. In this way the chief carpenter and the chief warrior resemble each other.”

In this paragraph, Musashi make sit clear that warriors, strategy masters, are very similar to master carpenters as they both employ people to reach their goals and deliver their objectives.

“In using men, the master carpenter must know the qualities of the carpenters. In accordance with their high, medium, or low ability, he must assign them different tasks, such as construction of the tokonoma; of the sliding doors and the shoji; or of the sills, lintels, and ceilings. It is appropriate to have support framing done by those with not much skill, and wedges made by the most unskillful. If one is able to discern the qualities of men in this manner, work progresses quickly and efficiently.”

Musashi continues on this point by saying that the carpenter has to know his people and divide the work being done to the right people based on their skills. If this is done well, then the job progresses smoothly.

And then Musashi concludes on the importance of knowing others in his description of what is to come in the wind scroll:

“Without knowing others, one cannot really know oneself.”

It may sound like Musashi is talking about directing or ordering people around. The master carpenter is the job boss and he assigns and supervises the people working for them as they do their assigned tasks. That does not sound much like partnership. However, when he talks about knowing others, he means it in the same sense that he means all of his instructions. He personally and expects students of his Way to practice and ponder the results of his practice. His life story is not one of a stern general barking orders and expecting obedience. He certainly cared for the people in his life and used them more than just as tools. Even in fighting well with swords, which is the heart of his Way, he tells his students that the Way is more than the tools, more than the swords themselves or however you flourish them.

Building a proper business partnership between functions is exactly like that. It is rooted in helping each other via your personal skills and then amplifying the ability of the whole group to complete your goals.

The foundation for a good partnership is trust and then mutual respect. You cannot enter into a partnership inside your firm without trusting the other people and you need to respect them. The structure of the partnership may exist, but without the proper foundation it will be just a framework with no substance and weight behind it.

In any sort of a company that requires a turnaround, there will be a disconnect between Finance and the other functions. Usually Finance is not part of business decision making and shunted off to the corner as been counters, but sometimes it is the other extreme and Finance is too powerful and everything is being run as a cost center with cost cutting and control being the only goal. Neither way works well and both result in sub-optimal results. You’ll need to bridge that gap and repair any damage done.

The first step is to clear your own mind of the conflict and issues that caused the problem to begin with. It is easy to build an us versus them case in your mind and start getting emotional about it. This does not help. The other parts of the company are all filled with people all trying their best. Put away your heart at war and put on your compassion and brains. Keep your ego in check as you will be. Setting an example for your staff. Go through your staff list and decide who are good fits in experience and temperament with the different business leaders within your company. Meet with your staff and make sure they understand that you are aiming for a partnership and that means they will be working for other functions more directly.

Once your staff understands what you want to accomplish, approach the business or functional leader or leaders you want to partner with and offer them dedicated staff that will work with and for them. Make it clear that they will have a major influence on the annual rating of the Finance staff assigned to them and they will basically become their resource. Make very sure that the assigned staff keep appropriate confidences work for their newly assigned function. Hopefully, if you picked the right person for the right fit, both sides should quickly start benefiting. The function gets access to financial analysis and advice before and while they are making decisions. Finance gets to see changes o the business sharpening before they are complete so that they can be properly planned for and accounted for. It really is a force multiplier when smart people with different skills work together as partners instead of working in silos.

You will know that the partnership is working when two things start happening. First, the business will start improving. By working together on common goals with the spirit of cooperation inside your company instead of defensiveness or unnecessary competition, better and faster decisions will be made. The second thing that will start happening is that you will “lose” staff into the businesses or functions you partnered with. The is about the ultimate compliment and a great recruiting tool because you can show actual progress and growth from Finance not only upwards within Finance but out into the business as well.

I have not had many bad experiences doing it this way, but there are some people that are so closed off that they cannot work with other functions or teams and want to be both secretive and controlling. They can be very difficult to work with and to convince that they should partner with you. It doesn’t matter how hard they make it, you need to. Find a way for the company to win. If the leader is not receptive to partnering, get your staff to try a layer or two down below them. Be friendly in meetings that you are in with the more difficult peer. Regardless of the reception you are getting, you should not be them and set yourself to fight instead of help. Get ahead of the decisions that need to be made and get that leader the information and analysis that you can do to help. Meet in private with them so they do not have to have anyone see them getting advice from you in public. It is not the best situation, but you are one of the top executives and you need to make it work.

Being a partner does not mean abandoning your integrity or not having Finance perform its traditional control and cost control roles. It is about making those objectives important outside of Finance so they are not just Finance goals. It is about embedding your skill set and advice into the company where finance gets to be proactive, not reactive. It is about teamwork and doing what it takes for the team to win, even if you do not get all the credit you may deserve.

It is about winning and making all the people you work with winners too.

Website with an online, free copy of The Book of Five Rings

The Book of Five Rings

Books, either in paper or on Kindle (all links go to Amazon.com)

The version I quote here:

The Complete Book of Five Rings

The Complete Book of Five Rings – Kindle version

The translation I first read

A Book of Five Rings: The Classic Guide to Strategy

A Book of Five Rings: The Classic Guide to Strategy – Kindle Version

An account of Musashi’s life

The Lone Samuari: The Life of Miyamoto Musashi

Fictionalized versions of Musashi’s life

Musashi

Musashi – Kindle version

Samurai Trilogy [blue-ray]

Collections

By Michael

On June 7, 2016

In Cash Flow, CFO

Last week I discussed Credit, today I will discuss the rest of the phrase Credit and Collection. Like the Credit process, how you run your collections process is important and deserves your attention. If you have a good credit process up front, you are probably OK on the reasonable expectation of collection criteria for revenue recognition, but you still need to collect the cash for your sales.

I will assume that you have a good credit process and you are selling to customers with reasonable credit. I will also assume that you have a good sales contract. In place, but I will discuss that in a little more detail. If your credit process is broken, you will have collection issues. That time two months ago when you caved in and said yes to make a quarter even though the customer had bed credit? This is where you face the music and have to deal with the consequences.

Your sales contract and/or invoice needs to make payment terms clear. I mean very clear and spelled out in proper terms. Incoterms or International Commercial Terms is well understood and often used in international commerce. Because these are well understood and legal interpretations are clear, I highly suggest that you use them. Make sure the terms are in the contract and either on the invoice or the invoice references the contract for payment terms. Be especially careful what the customer purchase order says. Many countries defer to the purchase order when settling disputes regardless of what the contract says unless the purchase order says otherwise. It almost can become an arms race where there is a contract, then you receive a “standard” purchase order back that does not reference the contract, then you send an order acknowledgment reaffirming that the order is accepted under contract or invoice terms. Every country is different, so I suggest you consult your lawyer here, but you do need to be careful.

I know it sounds pedantic and overly detailed for the new, strategic CFO, but every company needs cash and you are not going to be able to be strategic if you don’t collect well. Getting the contract done well, even if just contained in your standard invoice terms, is something that can be done well once up front and then just needs a little bit of maintenance and supervision going forward, something that your billing team can handle without much effort from you. I always check this process when I start a new CFO job (applies to Controller as well). If it is in good shape, then I manage on a exception basis. If it is in bad shape, I put a lot of attention to it very early.

One last tip that can help later is to try and preserve title until payment is actually received. You need to be careful about affecting revenue recognition as one criteria is title has to transfer, but a properly worded term and the expectation that you will be paid is normally sufficient. You also need to be sure that it is clear that they are responsible for losses and need to insure the goods.

The next step to good collections is to get your sales force engaged. Hopefully you are already doing all the basic things that build trust and relationship with the sales team (I find adult reviews of expense reports that allow for some discretion and paying them quickly once submitted really helps here.

You need the sales team engaged because they are the ones talking to the customer and doing the negotiations. So if you want something built in up-front, then the sales manager is the one that will do it. If you want a purchase order that resets terms caught, it will be the sales team that sees it first.

I know of two ways to get the sales force to help. The first is training. Take the time to train them in the standard payment terms the company uses and why they are important. Educate them on the main cash flow levers the company has and what the time based cost of money is for your company. Show them using examples just how much a bad debt costs the company. Show them how a side agreement can throw all the prep work and standard contracts out the window. Side agreements are import enough that I will do a blog entry just on them. If you spend time educating the sales force, you greatly increase the chance to get them on board and engaged.

However, this is just not enough. Sales people are very motivated by targets and pay associated with the targets. If their bonus is only based on making the sale, then they will not be motivated to put potential barriers in their own way by protecting the company. You absolutely should tie some of their bonus to eliminating bad debt and collecting the sale. The best way I have found to make sure they are motivated to keep following up with the customer is to only give them credit for bonus purposes when the payment is made. This is the simplest and most direct way to tie their behavior the the company’s hoped for result. More mature companies can also have metrics for bed debt and finding costs for the receivables the sales group creates, but no credit for bonus until collected is the most straightforward.

I get pushback at times from sales managers on this (I always try and stay engaged with the sales team as they are the best and earliest warning system for forecasting and customer feedback). Normally them complain that our harder terms are bad for their customers. My answer is simple, a “customer” that does not pay is not a customer. If I am being less polite to really make the point, I remind them that people that take things without paying are thieves.

I am sure that you have noticed that many of my blogs emphasize the up front process and usually I spend a lot of time explaining what I do to get it right. That is my natural instincts coupled with Six Sigma training. In a factory, the worst process to follow is to inspect quality in at the end and the best is to start with your suppliers so that you receive good quality parts. It is the same for Finance processes. One topic I did not cover here is billing, your invoices need to be perfect or whatever mistake is present will be used as an excuse not to pay, but I will discuss that another time.

I have noticed over the years that you should have very nice, persistent and organized people actually doing the collections. As funny as it is to joke about breaking people’s legs and all the other loan sharks collection methods, people do not like to pay mean, threatening counterparties. All you really can do is threaten to sue and in the USA that is not much of a threat. If there is either a cash flow issue or some form of quality dispute with the customer, they are not going to care about a lawsuit.

What actually works is polite and persistent follow-up. The customer will claim missing invoices, terms being different than what is in the contract, quality issues, moon phases, sun got in their eyes, vacation schedules of people who can sign cheques, pretty much any reason under the sun as a reason for delay in payment. Your collection team needs to document that they were told, efficiently follow-up internally for anything that is under your company’s control and then get back to the customer. They need to sound sympathetic and be very polite about identifying inconsistencies in what the A/P person at the other end is says. Quite often pure embarrassment at being caught in a lie (that is never specifically claimed by your collection staff) can cause the customer to pay.

If your team is polite and professional and keeps good records (CRM is best but a physical file works), you will get prioritized for payment. If there is a real issue, your collection team will find out because the people on. The other side will tell them because of the good relationship that has been built up. Your collections team should either work closely with the credit team or report to the same boss so that you get realtime feedback and can stop further sales if a customer suddenly turns bad. I don’t consider a company being protective of their own cash flow to be bad. If your invoice to them was incorrect then you gave them an excuse not to pay. Anything that you would do yourself needs to be responded to with polite but firm follow-up.

Finally, if a customer does not pay you need to take legal action. Your sales team will protest about relationship, but a customer that does not pay you has already broken their relationship. If you have credit insurance, your insurer may take over this process, otherwise you need to sue. The steps are always the same. First a legal warning letter then you file a claim. You need to get paid, not a future promise of payment after the legal warning letter as you need to move quickly.

By doing what I suggest in this blog, I have consistently been able to deliver industry leading collection statistics wherever I have worked. By spending the time to work more directly with the credit and collections team and build a rapport with the Sales team I have been able to keep everyone happily working towards the goal of getting cash into our bank faster.

Credit Control

By Michael

On June 2, 2016

In CFO, Finance

I have done a few blogs on some of the more public tasks and CFO has, such as Investor Relations and Earnings Releases and SEC Reporting (where the results of the process are public). This blog is about a process that if everything goes well will remain private because there is no news to report.

One of the functions that normally reports to the CFO is Credit and Collections. I will discuss collections in another blog to come, this one will focus on credit control. The whole basis of credit control is balancing reducing losses from bad debts while not excessively curtailing the ability of your sales team to sell. There is a very natural conflict point here between Sales and Finance (or Treasury as credit control often is a Treasury function, but Treasury should report to the CFO). Sales is motivated and pressured to increase sales. Credit control is motivated and pressured to reduce losses. In both extremes, you can have either no revenue (all sales are denied) or maximum losses (sales are made to anyone regardless of their ability or desire to pay). Obviously no organization wants either extreme.

Before I detail out what I think is important about Credit Control, this is a reminder of why you need it. If you want to recognize revenue on an accrual basis (when the sale is made instead of when cash is collected), the SEC has listed the rolling four conditions that need to be met (SAB 101):

“The staff believes that revenue generally is realized or realizable and earned when all of the following criteria are met:

• Persuasive evidence of an arrangement exists,
• Delivery has occurred or services have been rendered,
• The seller’s price to the buyer is fixed or determinable, and,
• Collectibility is reasonably assured.”

https://www.sec.gov/interps/account/sab101.htm

The final bullet says that before you can recognize revenue, you need reasonable assurance that it is collectible. The SEC is not often as direct when giving guidance but the four points are very clear. Since then, accounting guidance has echoed those 4 points and all US auditors and most foreign ones use those points. Revenue recognition is a key problem that can lead to either missed quarters or restatements. It is something that a good CFO pays close attention to. It is very damaging to your reputation and the company’s reputation to get this wrong.

The first two things you need to do is to ensure that credit decisions come from a fact based process and that you have a good person with sound judgment leading the team. The two best sources I know of for credit information is Dun and Bradstreet and the credit insurance companies. The other is your company’s experience which is mainly saved by the credit and collection staff but might be in your CRM system as well.
One bad source of credit information is the personal relationship of the sales manager with someone at the client. From the beginning before the credit application goes in to. The. Very end when you do the final rejection as CFO, you will hear a story of what a good guy the client representative and how far back the sales manager goes with them. Sometimes the relationship goes all the way to the top, the sales manager knows their CEO. I have never seen a case where that so called “good relationship” turned a bad credit into a good one. Even if the relationship is real, if the client does go into bankruptcy, the judge can claw back payments made to your company in advance of other creditors. I also have noted that when business turns bad for a company, the CEO is more likely to lie and exploit their relationships than lower level employees.

What is important to know is what the D&B report says and what your collections team says if they have previous experience with them. For example, you may set 30 day terms and the D&B report says that they are often late. If your staff has previous experience with them, they may be able to tell you that they always pay no faster than 45 days but that payment always arrives then. That would indicate that their credit is OK but that you need your pricing to reflect being paid 15 days past your terms.

On average, your credit team should be saying no to cases where there is doubt that the client is trustworthy. If you have 20% gross margin, every bad debt write-off needs to be replaced with 5x the revenue to recover the cost. They cannot say no to everything that is doubtful and there should be some balance struck between an outright no and lower credit limits or a mix of letters of credit, bank guarantees and deposits and pure credit. A good sales manager should be good at negotiating, so they should be able to work something out.

You have to set the right tone with your staff. Some of their decisions will get appealed to you and I have found that the credit team is almost always right. There are times where there is some factor they did not consider, but if you did what I said was important – have a good fact based process and a good leader, then when they say no it normally is justified. Almost always I end up pushing the sales manager to go back and get more security from the potential client. Sometimes I approve the request, but always only when I know something that the team did not know.

A bad reason to approve credit that otherwise would not be approved is because you need it to make the quarter. You’ll just write it off a quarter or two and make that quarter worse plus have people question your judgment.

Credit insurance can help defray some of your risk. If you are exporting, make sure you look into what government supported insurance there is. Many countries have some sort of scheme to reduce risk and will let you recover 70% or more of any loss. Agencies like that also are good sources of credit information and proper practice for the country and maybe even to potential customer. In your home country, you will have to find credit insurance from one of the several that provide it.

When exporting and selling into emerging markets, you need to be very careful when you extend credit. If there is no good rule of law and now ability to enforce contracts or payments, you probably should be requiring an L/C or payment in advance. Many countries have a very bad reputation for paying companies from other countries and in many, you cannot win in court against the “home” advantage your customer has. If you do extend credit, be careful and build up the limit slowly as the customer proves them selves.

As CFO, you have better access to banks and market intelligence than your staff does. Make sure that you communicate with them. A recent example for me was a competitor that also bought our product off of us. I felt that their business model was OK but they were not being run properly and were a bankruptcy risk. I communicated it with our sales leader and our head of credit control. They decided to stop selling to the customer and several months later they did go under. Because I communicated my knowledge, we had no exposure to them.

I wish I was always that good. In one case an Indian customer wanted credit. They were listed in India and not very strong but most of our customers (construction companies) did not have great credit. I had been convinced that extending some credit was OK but our sales leader did not get a good feeling from meeting them in person. He stopped the sale and one of our competitors extended credit and sold to them instead. That company went under and paid no one.

Finally, we were trying to do more business in China where my company’s factories were located. We had a potential customer that was public in China and had a market cap much higher than ours. Typically you get paid by bankers’ acceptances/notes inside China. In this case, the customer offered commercial notes. They were current on their debt and their balance sheet seemed ok. We made a large sale to them and they did not pay the commercial notes off, defaulted on their bonds (pretty much the first in China) and went under. It was an expensive lesson, and we did not makes that mistake again.

And please don’t forget to have your contracts, even your standard sales contracts, reviewed by a lawyer. A poorly written contract can turn a calculated risk into an unexpected disaster.

Business Entertainment

By Michael

On May 29, 2016

In CFO

Once I made it to the CFO rank, the offers from potential vendors for business entertainment significantly increased. This is something that happens as a matter of course with the position and it brings its own challenges with it. You also will do more entertainment for potential clients or lenders. Again, an area that you need to be careful with, especially with the FCPA and other rules to be followed (UK anti-bribery Act as an example, but most countries have their own rules. The rules on the books in China, for example, are quite strict).

I have one basic rule about accepting business entertainment. If it could influence my decision to purchase something, then I decline. The two different ways that could happen is excessive cost or something illegal. If it would be embarrassing to have the entertainment public, then it can be used to influence you.

I have a few other rules of thumb, but not influencing my decision is the main one.

When it comes to meals and bottles of wine that I would have, if the restaurant is a place I would go to and the wine is what I would feel comfortable paying for if I was personally paying for the meal, then I am ok with it. I will only accept sporting event tickets if the giver is coming with me. If the person wants to give tickets and not be there, I usually suggest that they be given to lower level staff and I would not take them. I just make it plain that I am passing the tickets on so the staff know it is coming from me.

If I get a gift basket that has food and wine that is too expensive, I just share it with people at the office. You can always send it back if it is really over the top, but it is not so easy and can be considered to be quite insulting in some countries.

All of the above is, of course, if the company policy allows it at all. I have influence over the rules and they should never be ridiculously tight (some places like Walmart have famously tough rules there), but you do need rules with fairly low limits to discourage undue influence.

It is very hard in countries like China to avoid receiving and giving gifts. Because you are likely to be governed by the FCPA, you need to be very careful to ensure you know who is receiving the gift and if they are a government officer. This is quite tricky as the government runs or owns many companies and parts of the economy. The local bank branch manager may be considered to be a government official. Same thing for hospital administrators and other businesses. Even if you think you are following the FCPA, the actual written laws in China are very strict. They are generally not enforced, unless the government decides that they now will enforce them. So make sure this is well understood and controlled.

Business entertainment does serve a vital purpose in that it allows you to spend time with key vendors like your bankers outside of formal meetings at your offices (or theirs). If you are going to be relying on their advice and work, it certainly is important that you get more information than just a rehearsed pitch in your office. A meal gives you a lot more time to get to know them and what you learn outside the office can give you some clues on if you should use or trust them. If you are reasonable and careful in the entertainment you accept, you also are sending a signal to them that it is the results and their cost that matters, not if they can get yiu Super Bowl tickets.

Business entertainment does not only have to be with external vendors. You can take your staff or key people in other departments out as well. At times you can break an internal impasse by taking the discussions out of the office. Obviously you should not abuse this (policies like the most senior person pays helps to reduce abuse), but the occasional meal with people from inside your company can help a lot more than another meeting reviewing a spreadsheet. Sporting events are harder to justify, but some beers and cheap bleacher seats at a baseball game are not expensive and a good way to reinforce the workplace bonds. Business entertainment also gives you a chance to relax the formal chain of command that many feel pressured to follow inside the office. I have received quite a few good suggestions from my staff over a meal after work. Suggestions that were not forthcoming inside a work conference room.

If you are entertaining internal staff, you need to make sure it is in a fair and professional atmosphere that does not exclude your staff of the opposite gender. Usually, I prefer a larger, mixed group in that case as it can reduce gossip, but if you treat everyone with respect and as fellow employees, not dating material, your reputation will be good and there will be less need to have public “chaperones”.

I do tend to watch how much I drink when I am out at a business entertainment event. I don’t drink that much anyways, but as the CFO you need to set an example. As fun as it may appear at the time, getting drunk just isn’t wise and you risk others drinking to excess with you and then later getting behind the wheel in a car. You are responsible for your company, do not forget that you are responsible for your staff as well.

That is not to say that you should not drink at all. Some countries like Korea, Japan and China seem to feature drinking a lot as part of the expectation of a business meal. Regardless of expectations, I always have been careful to not overdo it. You also need to be more careful when fighting jet lag as drinking really does not help and may make it worse.

Email Addresses

By Michael

On May 20, 2016

In CFO, General, Investor Relations

Like most CFO’s, I work with outside consultants, some that run their own shops. Far too often I get emailed by them from their personal email and the email itself if not reflective of the professionalism they are supposed to project. Sccrmom86 is probably descriptive of something, and I assume the 86 is your year of birth, but when you are proposing to do $50K of IT services, I bet you can do better.

I acknowledge that this is often just a matter of taste. Every once and a while, I get a comment about my Hotmail email address. One of the main reasons why I use it instead of Gmail is that it is not blocked in China and Gmail is. Some people seem to think that Hotmail is some form of “inferior” email, which I find quaint. This is partially from the viral release method that Google used and partially because Hotmail was one of the first mass public email systems. When it first came out, the web-based HTML (HoTMaiL was how they spelled their name) that was not connected to an ISP was new and bold. But because it is from an older time before the more modern Internet and because it was used by spammers and neophytes to the web, it gained an aura around it. Not quite as bad as .aol.com, but something that triggers a reaction.

I have been using a Hotmail address since 1997. I am not 100% sure if that is before or after Microsoft bought them that year.. My very first internet email address was on Genie and I can find it in the very early 1990’s via Google search. I had an @home address and a Comcast address. I had moved and lost access to my internet provider email address and that is why I decided that I wanted an address that did not link to an ISP and that is why I picked hotmail.

Google ran a very clever campaign when they introduced gmail – it was invite only at the start and each user received a limited number of invites, so it was rare to get one. The actual email system was quite robust compared to most out there because it incorporated Google search. This created extra hype around having a .gmail.com address even though it was just an address. Like Beverly Hills or other famous places to live, gmail.com took on an extra cachet. Now, of course, anyone can get a gmail.com address and Google gains so many emails to mine and search in return for providing the “free” service. Google has built a big business hosting email for companies, many no longer own their own servers, it is done by Google.

I have a Gmail address and was in the process of switching over to it as my main email with my Hotmail being used to sign up for things on the web (to steer spam that way) when Google stood firm against the Chinese government and started to get blocked by them. Today, if you do not turn on a VPN, it is hard to get Gmail inside China.

I also had discovered something interesting. I had used my Hotmail address for years to sign up for every drawing or other registration that was out there. I had thought that the email would get flooded by spam and what I have discovered is that Hotmail has a very good background system to filter out the spam. I had to use my Hotmail email address as my personal one inside China if I wanted to consistently receive emails when they were sent instead of time shifted to when I turned a VPN on. Microsoft has also rebranded Hotmail to Outlook.com to match with their email client.

What this experience taught me is to disregard the immediate reaction I feel towards the domain. Silly or inappropriate addresses still trigger a reaction, but the domain not so much. AOL.com means that the person used dial-up Internet and maybe was the real person behind Sleepless in Seattle (you got mail). Dial-up means they were early to using the Internet and have a long history behind them.

It also has caused me to recognize the power of brands and their reputation. The fact that the domain name in an email address, which is a pretty pedantic item, can still cause an emotional reaction is a sign of the power of branding and the importance of your reputation.

Finally, I much prefer emails from businesses that tie into the name of the person. It makes it much easier to remember and use than initials or some description. You can tag your title and address in the signature block of your emails, no need to make it part of the actual address. If your address is just your initials, it might be shorter but it makes it harder to remember.

All of this advice is for business related emails. Personal email addresses are different and can and should reflect your personality. Be careful if you use several aliases that actually go into your personal email box, as you don’t want to accidentally send out a personal email address to a business contact. Also be aware that applying for a job is not personal and I suggest using a more professional email address.

How to say goodbye

By Michael

On May 12, 2016

In CFO, Investor Relations

“We’re gonna teach ‘em how to
Say goodbye!” – Hamilton “One Last Time”

Every CFO job has its beginning and every CFO job has its ending. There are important things to consider when starting in a new role, but often little thought is given to how to end your role when you move on to your next job.

There are two circumstances in which you leave your job – voluntarily and involuntarily. As a fact of life, better opportunities may come along and you may decide to take them. Or you may simply decide to retire or take a break. Or maybe personal or family issues will come up and you can no longer do the job in the way you think it should be done. All of these will result in you leaving your job.

Another simple fact of life as a CFO is that you are vulnerable. If there is a change of control there is a high chance you will be let go. If the CEO changes, you can easily be let go. If any one of the thousand mistakes that could happen in your financial statements happens and you do not catch it before it goes public, you probably will be let go. If the business struggles and targets are missed and your boss is under pressure to do something, you can get let go.

No matter what, leaving is one of the main reasons why you have an employment contract. Your rights and pay over termination should be well spelled out. Norms different by country and industry, but you can probably find example employment agreements in SEC filings around the time the CFO was hired and you probably should have a lawyer review your agreement and they can give you advice.

Leaving is always emotional. Even if leaving on your own terms, you may feel that you are owed something more. If you are being let go, it takes a will of iron not to let emotions get to you and even then you are probably just masking your feelings. You need to let that emotion go. You are a businessperson, and you have a responsibility to all the employees in the company.

Now if you discover fraud or some egregious issue and after you out the problem they fire you, then maybe you can sue. The unfortunate fact is that even if you win, you are unlikely to be hired by another company. The CFO is supposed to protect the company, not sue it. If you are getting what is in your contract, then you don’t really deserve something else, and you need to be mature and accept it.

In my career, I was only impacted in a way that was not mutual once, and that was via a CEO change. The CEO needs to have the CFO they want, the partnership is too important and that is why the contract exists.

Normally you are leaving on your own terms because you want to, but you still have a responsibility to where you are leaving. You do not want to do it poorly and hurt the staff that has been loyally working for you. You don’t want to hurt the company as it only reflects back on you.

Give your boss as much warning and time as is reasonable. It can be dangerous to tell them before you have accepted another offer, but be fair about your start date. If you are just wanting to step down and pursue other things, then you may even be able to set a date further into the future with the provision that if they find someone sooner they bridge your pay until the original agreed upon day.

Be positive in your discussions with your staff. Many of them may be emotional about you leaving. You are still their CFO, even if you are emotional you need to tell them to think with their heads and give it a few months and judge on the new CFO, not their feelings for you. You would not want to start a new job and then have your new staff quit immediately. Of course, they are all adults and can make their own decisions, but try not to inflame their feelings. I have tried to model the excellent bosses I worked for early in my career and genuinely care about my staff, even if I have high performance expectations. Make sure you say a proper goodbye, you never know when your paths might cross again.

Wrap up and hand over the projects you are working on. Clean out your office so the new CFO does not move into a mess.

When talking to outside investors and the press, be professional and positive. Even if they are letting you go, there is no advantage to disparaging your old place you worked as it reflects poorly on you. It is easier when you are leaving on your own terms, but make sure you praise your staff and their ability to execute. They are the people that actually were doing the work for you, so it is right that you express gratitude when you leave. Reassure outside investors that the business is as strong and valuable as the company has been expressing. The CFO leaving does cause some concern and if there is no real cause for alarm make sure that message is delivered.

Finally, leave on the best terms you can with your former boss. There are a bunch of selfish reasons to do that, like good reference responses in the future, but this is another place where you should reflect on the opportunity you were given. They trusted you enough to hire you and you probably worked long and hard on key projects together. You faced investors as a team and answered your Board’s tough questions. I don’t think it will be hard to say thank you.

Saying goodbye is hard. I hope I don’t have to do it many more times in my career.

Work / Life Balance

By Michael

On May 3, 2016

In CFO

I wish I had better news, but if you are wanting to be a CFO of any sort of larger company, it will be next to impossible to maintain any sort of reasonable work/life balance. It actually does get better in the sense that you have more control over your schedule and can plan around important family dates, but that really does not help as much as you would hope it would.

The primary accounting schedule that focuses on quarter ends is the same even as CFO. Your intensive work is delayed about a week from earlier in your career as you probably are not directly involved in the preparation of the first draft of the numbers, but once they are available you will be reviewing them and working on the earnings release. This also activates the forecast refresh cycle as you try and dial in the guidance you will release with the earnings release.

The quarter end crunch tends to be even more condensed because of prepping for the Board meeting. You will be a key presenter at the meeting and quite often you are explaining proposed company action with the need for aboard approval. As much as you may think that you are saving time by not preparing the raw numbers, reviewing them to ensure there are no errors and preparing the explanations and message is actually more time consuming and you also need the fairly final numbers before you can close it off which means you get even more crunched by any delays.

The quarterly reporting cycle in intense, but at least it happens with the same timing from year to year. If you are just having a normal year, the only other time pressure that will push your work over the top is travel. Very often you will fly on a weekend day so you can arrive on or before the Monday start of your work week. Phone calls and emails help, but you’ll be traveling to your major sites at least once a year to meet your staff there and do business reviews. You’ll also be traveling for investor relation events and non-deal roadshows. These are more instances where you will have an illusion of control over timing but actually less ability to control it than you would like.

You have to plan travel around your quarterly earnings releases and Board meetings, so the window is more condensed. Although you can pick and choose which IR events you attend, there will be major events that you really should be at with fixed dates so you do not have as much flexibility on them. Major overseas travel takes even more time on planes and causes jet lag issues as well. You are likely to be less effective in the first few days you are back and often that means going to bed earlier which takes away family time.

Again, this is somewhat manageable as you can usually control the dates of internal meetings and move them to a time that is more convenient for you. It still takes time for the travel and the follow-up, but if there is an important birthday or school event, you can plan around it.

The other time requirement is staff coaching and development. I personally never encourage too much socializing in the office and I think that professional relationships can be damaged if overdone, but you absolutely need to spend some time getting to know your staff. So even if you are home, you can be sure that there will be so,e evenings where you get home later because of this.

The real time devourers are M&A activity and capital market deals and other major financings. There is no escaping the central position for the CFO in those deals, and you have little control over when they happen. Capital market deals normally happen after you report and before it is too close to the next reporting period. So that spacing between the major reporting deadlines can be eaten up by a deal. If your company is active in the capital markets (one deal a year), then you can expect to lose a lot of personal time in one quarter. Again, you are not the junior associate lawyer, the manager at the auditor firm or the junior investment bankers that really get slammed with the detail work, but you will still be quite busy, as the documentation gets more final you will be the go to person for most final decisions and you’ll probably be running the deal. If the deal is a rated deal, then the rating companies are going to want to hear from the CFO and probably meet them in person. That means you.

Major financings like in the project world or bank debt also take a lot of the CFO’s time. They also tend to require more internal effort as the division of labor is quite different for those types of deals than one driven by an investment bank. So you are not quite so tied to the markets and probably do not have to do a deal roadshow but you will have to do a lot more review of the internal work performed.

The final and uncontrollable work demand that is likely to swing your balance quite a bit towards work is M&A activity. Even if you are the acquirer, you will not have that much control over when it starts and once the process is kicked off, you will likely be the center of it. You not only need to do due diligence, you probably will have to raise funds in a financing as well. So you will not only have to run the buying process, you will be running the funding process as well. M&A always has extra time pressure and you have to expect the unexpected. As a public company CFO you will be filing SEC documents as well if the purchase is large, so that is another task on your shoulder.

On top of all these additional activities, you will have your day job of leadership and managing the areas you are in charge of and where the company needs your attention.

You will not have good work life balance, but you need to manage it to make the most of the opportunities you do have. You need to be able to prioritize, schedule and take more add=vantage of the friend and family time you do have.

I have emphasized the importance of communication in many of my blog posts and it is even more important outside of work. You need to know what is coming up with your family and friends and you have to know what is important. When traveling, Facebook and similar social media (I recommend keeping a smaller and more personal friends list while serving as a CFO) can be used to keep up with the activities of your social circle and to let people know where you are and what is going on with you. It does sound a little sad, but you cannot spend as much time chit chatting to catch up, so social media can be helpful.

You also need to have frank conversations with your family about what is coming up or happening with work. They can also work with you to move around some activities so you can be there.

Finally, you will have to make a choice about some friends. You will only have so much time you can spend and you will be spending it a lot with your family. Maybe use this process to shed some friends that have turned out to be a negative source of energy for you. I also find that friends that also are as busy as you are more understanding.

As I said when I started, I wish I had better news, but you will struggle with this your whole career and you will not be alone.

Annual Reports – SEC filings

By Michael

On April 26, 2016

In Accounting and Reporting, CFO

I started long enough ago that an annual report used to mean the nice marketing annual summary with pictures and a letter to the shareholder and the financials summarized with some graphs and commentary. Very few companies do that anymore as the Internet allows for a much more direct and continuous medium for communication. Today, the annual report means the SEC filing – the 10-K or the 20-F (for foreign private issuers). I have prepared and filed both and there is not much difference between them.

The annual report as filed with the SEC has several main sections. These are the business description, the risk factors, the management discussion and analysis and the financial statements themselves (which includes the auditor’s report). As the CFO, you are the person most responsible for the accuracy of the annual report and when you sign and file it, you will be taking significant personal responsibility should it be wrong. In a larger company you probably will not be preparing the bulk of the report yourself, but you will be reading every page and making changes where relevant.

As an individual shareholder, if you consider yourself to be a fundamental investor, you really should read the annual reports of the companies you invest in or want to invest in. You don’t have to read every page in detail looking for errors like the CFO has to, but I recommend at least skimming through all the sections. As I give advice throughout this blog entry to my fellow CFOs, I’ll also have an aside or two on how individual investors can use the information as well.

My first CFO advice is that there are no copyrights on other filings. WWW.SEC.GOV has the filings from other companies, both in your industry and outside of it. If you want to see how others word common accounting items or risk factors, you can find it there. Do not be ashamed to steal shamelessly. My second CFO advice is that the annual report is not just a required disclosure document, it is a marketing document as well. It is your chance to clearly explain your strategy, what risks you face, and to clearly present your financial results and what information you think is needed. You need to get the SEC and legal details right, but the annual report is going to be incorporated by reference into any capital market deal you do and will be read by the counterparts in any private deal you propose, so you might as well get it right.

A typical division of effort of the 4 sections is this: 1) Business section is senior management, investor relations and maybe the marketing department. 2) Risk factors is Legal with senior management review and 3) and 4) MD&A and Financial statements are Finance, mainly the Controller. You’ll be project managing the preparation and you’ll do the final quality control but you should have a fair amount of help on this. In a smaller company you can expect to do a lot of this yourself, but this is a company filling and your boss and other senior management should help somewhat. You should have prior year filings to act as the template for this year. Even if this is your first annual report, you should have the S-1 from the IPO to be the starter for the annual report.

I came up to CFO from a Corporate Controller role, and I had previous experience at preparing the financial statement part of the annual report plus some experience in the business section in previous jobs. So reviewing the report as CFO came naturally to me, but all CFOs should pay a lot of attention to the report. It is easy to delegate the report down to your reporting staff and there are outside lawyers and accountants that review the report as well. This makes it even easier to assume that all is well with the report. However, the outside parties tend to be ignorant of the business conditions you are operating under and they will not necessarily have only your interest at heart when they word certain sections. In particular they will be very conservative on sections like the liquidity section. Make sure you are comfortable with the wording.

What I do when I review the annual report is sign and date the front page and then initial each page even if I make no other changes. I handwrite edits unless they are long in which case I type up a rider. Version control is important and I find that handwritten edits make it easier for my controller to maintain control of the master copy. The signed report and initialed pages and handwritten comments are also good proof that the report was reviewed. Some lawyers want all working copies to be destroyed after the annual report is filed, but I think they are good to keep in case there are questions later.

When I review all sections, I look for grammar and spacing or missing words mistakes. Even with a lot of eyes looking at it, it is surprising what will slip through. I try and read important sections backwards one by one as that helps isolate words and aids in proofreading.

I also review for meaning and to ensure the English is smooth and natural. Even in the USA, many people on your staff might speak English as a second language. It is quite possible that people reading this blog speak English as a second language. If you don’t consider yourself to be very strong, have a native speaker read the business section and see if they have any suggestions. We circulate the business section within the different functional areas to see if they have any suggested changes. Usually we get a good edit or two just by doing that.

The risk section is useful in two ways. First is the ranking process. You should have the most serious and relevant risks first in your list and they should be listed in descending order of importance. The very act of ranking risks often leads to additional risks being identified and included. The second value to the risk section as it gives you a list of threats that you need to ensure you have countermeasures to. Look at the top risks that you and the management team think are the most serious and ask if you have any countermeasures in place. If you cannot think of a credible solution to reduce or eliminate the main risks identified in your filing, then you have a critical issue that needs to be addressed by the management team.

As an individual investor, the business section can be interesting, but the descriptions tend to be somewhat top level. You usually can find employment numbers, including by function and some geographic and segment information on their business, but I normally do not get all that much purely from the business section. If you are brand new to the company or the industry it certainly helps. One test that I do when looking at a new company is ask myself if I understand what they are selling and what their strategy and strengths are. If I can’t articulate it after reading the business section then I need to test my assumption that I understand their business well enough to invest long term in them.

The risk factors are more interesting to me. The can be boring legal boilerplate, but the order the company lists the risks and the way it is worded can provide valuable clues. What is extra valuable are new risks added compared to the prior years and/or changes in risk order. This is the section where management is trying to warn you about what might go wrong. It is pretty much the only section where what might go wrong is discussed. I find it valuable to weigh how likely the risks are and what a reasonably prepared management team can do to prevent the problems. If the risk seems likely and there is not much that can be done about it, then I worry about investing. I also try and think of what risks are not listed. If I can come up with some that are reasonable and management does not address them in the risk factors, then I worry.

I find the MD&A section the least useful. For years the SEC has tried to make it better, including insisting on more detail and better use of plain English, but almost all MD&A are a dry recitation of this year versus last year with one or two top level reasons given for the change. The liquidity section can be interesting, and this is an area that I try and watch my outside service providers closely. They like to make it sound conservative and more risky than it actually is. I have worked at companies with large cash balances and virtually no conceivable liquidity risks and the auditors are still trying to change the language to something that implies that there are real risks of a crisis. If you are working for a company that needs access to the debt market and the capital markets, then you don’t want an overly conservative section here. Obviously you need to accurately portray your true situation, but the auditors stress test going concern assuming lots of bad things that are unlikely to happen occur, and then want to reflect those tests in the liquidity section. Those risks belong in the risk section, not in MD&A. The commercial paper market crashing like in 2008/2009 is a risk, not something that needs to be discussed in detail in the liquidity section, for example.

As an individual investor, I find MD&A to be dry and not that useful as well. If I am trying to build a top level model, then sometimes I can find explanations of one time items to exclude, but normally I just skim read that area and check to see if there are any time bombs in the liquidity section. I don’t find income statement models all that useful as an investor and tend to concentrate on the balance sheet and the cash flow statements anyways.

The last section is the financial statements and if there is any section that is the “CFO” section, this is it. The three main areas here are the auditor’s report, the financial statement tables and the notes to the financial statements. Sometimes Sarbanes-Oxley matters as well, but only if there are a failure.

The audit report is simple. Either it is a standard report or there is a big issue. If the auditors have to modify their report, then there is a problem. If your auditors tell you that they have to modify their standard report, then you know you have a major problem.

The financial tables should be the same as and your earnings release, albeit more detailed. They were already checked by the auditors before they were released. It is not unknown to have something change but it is a little embarrassing. It has never happened to me so I am not 100% sure what I would do if it did happen. When I have seen it happen, it is either a subsequent event that accrues back to the already reported quarter or a balance sheet reclass from long term to short term.

The notes to the financial statements are where the real detail is. You need to describe your main accounting policies and then give a fair amount of detail, including segment reporting, for the different balance sheet and income statement accounts. The rules for segment reporting are straight forward, if management runs the business as different segments and uses internal reports that do it and the numbers are material, then you need to segment report.

I think the income tax note is the one that can cause the most issues, especially the disclosure on uncertain tax positions. Make sure you have the right technical help here and try not to paint a target on your back with your disclosure.

As a CFO, this is just another technical section and I mainly worry about getting the accounting and disclosure right. I do focus on the actual wording, but a lot can be found in other filings and is dictated by GAAP anyways. As an individual investor, the notes are a goldmine of information. All the detail that is glossed over in the earnings releases and calls is there. If there is a “smoking gun”, the notes will have it. Read that section very carefully.

As a closing note, I have written something 2-3 times a week for the past few months. I had a few people message me and ask about last week. One key skill in being a successful CFO is balance. My youngest daughter was home from school last week and I spent it with her. I should be on schedule again for a while at least.

A simple but career destroying problem

By Michael

On April 12, 2016

In Accounting and Reporting, CFO, Finance

The number one fundamental error that causes material errors and misstatements in SEC reporting is spreadsheet errors. There are plenty of technical errors you can make and there always is the risk of management override and deliberate misstatement but the number one way is to shot yourself in the foot because you make a basic spreadsheet error.

Spreadsheets are used by all accountants, and it is impossible to operate without them. We all know that they cause problems, but we use them anyways because there is nothing better. Here are some recent examples of reporting errors (taken from the link below, I have not used the product they advertise and the cases cited are public and in other articles)

http://www.audinator.com/Horror_Stories.html

Fannie Mae makes billion dollar spreadsheet error overstating gains
Fannie Mae filed a Form 8-K/A with the SEC amending their third quarter press release to correct computational errors in that release. “There were honest mistakes made in a spreadsheet used in the implementation of a new accounting standard…which resulted in increases to unrealized gains on securities, accumulated other comprehensive income, and total shareholder equity (of $1.279 billion, $1.136 billion, and $1.136 billion, respectively)”

Share price drops by a third, CEO resigns due to spreadsheet error
UK support-services group Mouchel discovered an accounting error in one of its key spreadsheets that led to a £8.6m downgrade of its profits. The company pension-fund deficit had been wrongly valued as a result of the spreadsheet error.

Shares of RedEnvelope fall more than 25 percent due to spreadsheet error
The online retailer of specialty gifts drastically reduced its fourth-quarter outlook and said its chief financial officer will resign. “They were underestimating the cost of goods sold”, said Stanford Group analyst Rebecca Jones Kujawa. “It is likely CFO Eric Wong is being pushed out because of this error, which could demonstrate a material weakness in controls over financial reporting.” RedEnvelope spokeswoman Jordan Goldstein said the budgeting error was due to a mistake in one cell of a spreadsheet that threw off the entire cost forecast.

Kodak restates income downward by $11 million due to spreadsheet error
$11 million severance error traced to a faulty spreadsheet. Kodak spokesman Gerard Meuchner said “There were too many zeros added to the employee’s accrued severance.” Robert Brust, Kodak’s chief financial officer, called it “an internal control deficiency that constitutes a material weakness that impacted the accounting for restructurings.”

AstraZeneca forced to reiterate earnings forecast after spreadsheet error
Britain’s second largest drugmaker AstraZeneca scrambled to reaffirm earnings forecasts after an embarassing spreadsheet error left investor confidence sorely shaken. The behemoth drug manufacturer said the spreadsheet gaffe occurred during “a routine consensus collection process.”

I can also give a personal story about a spreadsheet error that certainly caused embarrassment and could have been worse. Earlier in my career, when I was Controller of a company, we were being bought by another company and we had bankers advising us. At the last minute, right before we filed our last 10Q as a public company, our lawyers decided we should disclose the banking fee we would be paying to our advisors. We had hired the bankers in the past for the same potential deal and the letter from the earlier, failed deal had been updated to a current date and signed again by our CEO without being reviewed.

The formula for payment was based on a certain definition of enterprise value and the fee jumped as each major valuation range was cleared. I built a quick spreadsheet model off of the balance sheet spreadsheet that had been checked by us and the auditors so I knew all the base numbers were right. I entered the formula for the fees, all in one cell instead of stacking the different ranges in a cell for each of them. The number that came out was in the low double digits of $ millions, and I thought it was high looking but the bank had been working a long time and had not been paid for any work yet on previous, failed deals, so I used that figure in the disclosure. My boss did take a quick look at the number, but no one checked my spreadsheet.

I had made a formula error. For the very last range, I was off one decimal place in the formula and the spreadsheet understated the amount due by 50%. The actual amount was a surprise to everyone and had the CEO actually done a calculation, he probably never would have signed the letter. It ended up being an issue for me because I stayed on and the acquiring company was concerned that the fee was being hidden on purpose. Once I showed them my error, I then ended up in the middle of a large investment bank’s M&A group fighting with their country office overseas that was being pressured over the fee. It eventually was resolved, but I didn’t get as smooth a start as I had hoped in my new role and it was a big distraction for a while.

After that narrow escape, I became much more careful about the base spreadsheets me and my team use in SEC reporting. Careful review for errors has caught several that would have ended up being material misstatements. Two common places where I have found errors is in the tax provision spreadsheet and the inter company accounts reconciliation spreadsheet. Both are updated quarterly, the number of rows often changes as items are added or subtracted and both have multiple people inputting data into them.

The first and still main formal study I know of on spreadsheet errors is by Raymond Panko of the University of Hawaii. I have provided a link this site below. The conclusion of his initial study was that spreadsheets are large and complicated and almost never follow a formal software development process designed to eliminate or reduce errors. Therefore it was not a matter of if there is an error, but how many.

His site lists the common errors he found in his study and how to find them. He also describes a standard development process designed to reduce errors and find any that are created. He also reviews the results of several studies that were done around 2004 after Sarbanes-Oxely became the new standard for companies to follow. Control over spreadsheets is a key internal control that all public companies need to address.

http://panko.shidler.hawaii.edu/SSR/

This problem is pretty well known and it is not hard to find newer articles on finding errors in spreadsheets. For example, this one: http://www.journalofaccountancy.com/issues/2015/nov/how-to-debug-excel-spreadsheets.html . Even with the recognition that there is a problem, CFOs are still losing their job because of simple spreadsheet errors leading to material reporting errors, misbid contracts, improper internal reporting and analysis and other embarrassing issues. It does not inspire Audit Committee confidence if you present to them and they find an error.

I suggest that you take a look at the Planko articles and do a little search for more articles on what can be done to reduce errors. Call a meeting with your staff and review this issue and discuss what they are doing to make sure they are getting their spreadsheets right. Hopefully they all know about the danger already and you already have a robust process. If not, get one in place ASAP. Even if you do, spot check a couple of the more complex spreadsheets they use and make sure you cannot find any errors.

An ounce of prevention now can save you from a $25M fine later after an error is found and you have to restate your results.

Going beyond the headlines

By Michael

On April 5, 2016

In CFO, Finance, Investing

Every day, at the end of the day, there is a series of articles wrapping up the market. There always is some sort of facile explanation in the headline and then a few facts in the article around the headline. Every market day and usually a wrap up on the weekend. There normally are a couple of pithy comments and reference to some news item of the day. Typically there is a comment on the Fed, or the latest job news, of maybe a reference to Asian markets or some economic item in Europe.

There are similar news items on individual stocks, especially famous ones, just about every day as well. Some little news items is grabbed for Apple and attached to whatever the stock price movement is that day. Even for lesser followed stocks, when they do their earnings release any movement is attached to the market’s reaction to something in the release or a comparison to analyst expectations. Often there is a quote from the latest analyst report supporting the reasons cited for the stock move.

I can tell you, if you want to be a better individual investor, you need to learn to ignore such articles of reasoning. They tend to be very shallow and are written more to fill space than they are to offer any sort of thoughtful response to what actually has happened. Same thing for much of the instant analysis that is on the live financial news shows.

I am not saying that real news does not move stocks. If a company genuinely releases unexpected news, either good or bad, then the stock may immediately react. If there is a major geopolitical news item like a terrorist bombing in a financial or political center or some surprise currency move, then markets can and often will react and that news will be the cause of the reaction. However, news of that nature tends to be pretty rare and even rarer for an individual stock.

In my first substantial blog post for this site, I discussed my strategy of selling puts to generate income and profit. In that blog I listed several long tables of share prices that I suggested should be studied before deciding on a stock and committing to an investment. In my blogs on investor conferences and non-deal roadshows, I talked about the process the typical fund uses to decide to buy and sell and emphasized that the process tends to be slower without an immediate reaction causes by one conference meeting or visit in their office.

The same thing can be said about the analyst reports that appear right after an earnings call. Normally the analysts are rushing to get something written and they have call after call during earnings season. Their time with management is normally limited to. The questions you can hear on the call and about 15 minutes afterwards are all the time they normally get with the company and then they publish. Quite often what is written is a rewording of the press release with a highlight or two from the conference call. Earnings calls can be catalysts but they are more of a retail investor or a fast trading hedge fund play than the longer term investment trends that give stocks their underlying values.

If you want to learn about the market or a company, you need to do more than just read headlines or look for one answer to what something is happening. A good example is oil prices and energy stocks. There is a connection between the two, but small changes in oil prices that are within the range of normal expected volatility are almost for sure not causing the move in one particular stock or sector. An above average increase or drop is more likely a larger investor increasing a position or decreasing a position, and the chances that it happened that day because of the news item being identified is almost zero. A .5% move in Yen value is not going to change investment decisions on a company that gets some of their revenue from Japan.

This goes back to my advice to CFOs on doing the outlook section — you need to look past your spreadsheets and listen to the other functions and what they are telling you. When you are making long term capital commitments, you will a lot of simple answers to questions. These answers may sound right, but when making an investment decision you need to think a little more on it. Make sure that your question was really answered. Try and look at the question from a couple of more angles and ensure that you are making the right choice for your company.

Of course, most individual investors don’t have the training or the background to understand what is happening with the markets. From reading books like Flash Boys by Michael Lewis, even my understanding of the trading in the markets is somewhat shaken. With all the “Dark Pools” and algorithm based trading that is happening and the speed and velocity of dollars being committed, even the basic fundamental reasoning for stock valuation might be broken down. Individual stocks may get caught up in this trading and change pricing for no reason other than it was traded.

I try and keep my financing deals as simple as possible and avoid derivative collars or enhancements to them because even after I study carefully I cannot account for all of the factors that might move their deciding valuation factors more than expectations. If I cannot reasonably assess risk, then I do not commit. It is the same for me for investing decisions. If I do not understand and agree with how a stock is being valued, then I do not invest in it.

This blog entry is the reasoning I use when I encourage people that ask my advice on what to invest in to avoid individual stocks and buy low cost index funds. You have little chance of getting rich quickly but you’ll at least make the market average returns which are quite compelling. If you want to gamble with a stock, accept that you are doing no more than buying a lottery ticket or pulling a slot machine handle. Nothing wrong with dreaming, but recognize that you are dreaming. As a CFO, you need more than a dream. Lottery tickets are not a good strategy to make sure that you can meet payroll and pay suppliers.

I am not saying that you should not invest in individual stocks. With careful reasoning and some luck you do have a good chance of beating average returns. As a CFO you will be asked to greenlight new products or business areas. In the short run saying no is more safe but you may not have a long run if you say no to everything. Just make sure you understand the ways you can lose money on the deal and what you would do if that happened. If it does happen, you will at least have a plan. No different than if you were acting as CFO. You can take the risk and say yes to a new area of business or a new customer, but have a back-up plan you can execute on.

If you do want to invest in a particular stock, investing in something you know and maybe not in the industry you work in (to avoid concentration risk). Try and understand the product you like and other investing reasons for the company. Try and figure out who owns the company and why they would want to own it. A classic example of this for me is Hasbro. They own Wizards of the Coast and they own Magic the Gathering and Dungeons and Dragons. I play and like both games and think that Magic is important to Hasbro and I can at least tell if that game remains popular. They pay a dividend and raise it annually which I like. They have the rights to Star Wars for toys. They have been able to monetize their other properties in the form of movies that have done well at the box office. All were good reasons to buy. That stock is up almost 100% for me and continues to pay a good dividend. Every quarter there is a news article of two update based on the earnings release but because I keep track of the company, I know that the news articles are very superficial. I think I understand the main valuation drivers and what causes short term swings in value (short term is usually tied to movie releases).

Musashi tells you to study well. Not just your sword work and strategy, everything you do. Don’t be fooled by what is on the surface and easy explanations. Understand your decisions and make them as well as you can. People are depending on you.

Category: CFO Page 2 of 4

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