CFOs guiding PE ships for profitable exits

The Entry: The Entry of Private Equity investments is a stamp of approval for business owners of having arrived and also helps establishing values & success for the business built by them over the years. The PE investments may be used towards areas like debt repayments, future expansion, cashing out by existing promoters etc. With this change in the company's ownership there are also significant changes in its finance organization. This is especially true when the new owner is a private equity ("PE") firm. PE firm's have a huge appetite for data, particularly financial data of what drives a business. PE firms focus the company strategy to create value for shareholders. In such situations, a company's CFO, as well as other functional areas, needs to align themselves and support the new Strategic direction.

PE requires the CFO to create value by combining his financial expertise with Operations experience to make informed business decisions. Traditional company's finance organizations are sometimes subsumed by monthly process and status quo. While the accounting process requires significant efforts of the Finance team for recording of large volumes of accounting transactions and the management of ERP systems followed by consolidated financial statements there is limited strategization expected. The traditional CFO role gets further burdened by quarterly reporting addressing all compliances. The entire process can be extremely challenging for a company due to business complexity, the continually expanding compliance environment and the speed at which financial results are expected.

PE firms certainly recognize the importance of the monthly closing process and the need for historical financial statements. However, they may also see these statements as chronological reports that do not provide enough detail to support business decisions. The monthly close often prevents the finance organization from dedicating resources to company-wide initiatives. Furthermore, due to the high level nature of reports produced by a finance organization, they may sometimes offer little value to business decision makers, particularly those in operations and sales. These departments may often have their "own set of numbers" or strategy produced independently from the finance organization. Consequently, a company's finance organization may become detached from the business decision making process,

PE needs Value Creators and in today's economic environment CFO is the best Value Creator partner: PE firms have a heightened awareness of the need to create value. Their ability to raise and invest funds is dependent upon high targeted returns in a relatively short period of time. Furthermore, their business model is no longer based solely on financial engineering and leverage; driving performance improvement has taken on an equally important role. In order to create value, finance needs to provide insight and impact the decision making process. Creating value also requires getting the right information to the right people at the right time. CFO's create value by ensuring growth is profitable on an EBITDA basis. EBITDA based reports are also prepared for Profit Centers, Cost Centers, Shared Service Centers and Overhead Centers. They detail reports for every line of service, product or project and include pricing, volumes, unit cost and margin information. Although this sounds simple, the determination of what actually drives revenues, costs and EBITDA is often not easy. Furthermore, traditional allocations, chargeback's and intercompany fees need critical review in the EBITDA world. In partnership with all functional areas, a CFO report detailed operating results, identifies trends and converts that information into a valuable insight. This process leads to gross margin improvement and the identification and management of cost reduction opportunities.

Capital expenditure ("Capex") reporting is another area that is typically improved to create value. Although PE firms are willing to invest in Capex to meet growth targets, such expenditures are highly scrutinized. Prior to an acquisition by a PE firm, many companies make Capex decisions based on operating needs and available cash. However, in the value creation process, the entire company has a responsibility to plan current and future Capex requirements. The role of finance is to assist in the preparation of costs estimates, revenue benefits, impact on operating costs and resulting internal rates of return, as well as assessing actual versus expected benefits.

CFO partners with the board to also create a robust Performance Management System. It is perhaps the biggest challenge in the value creation process for the CFO to partner with the Board and investors and develop and implement performance metrics. Performance metrics are based on dynamic facts of operations and sales that have an economic impact and are derived from customer, vendor or employee activity. Performance metrics tie companywide activities and performance into a common set of measures. With performance metrics in place, the company can measure its activities and performance against specific and manageable goals. Performance metrics need to be focused and credible. The most valuable metrics are aligned throughout the organization and all stakeholders can understand how their role impacts performance. In order to achieve this, a company must establish a common base of data and processes that combines both financial and non-financial information and provides clear and consistent insights. This often requires realigning people, functions and processes from their traditional roles.

Finally the Financial Transformation: CFO's should ensure that they take a clear mandate from both the PE and Board. An initial briefing on the mandate, followed by training sessions and effective organizing and planning, can greatly benefit the development and implementation of this transformation. Also, introducing the finance organization as a business partner to all other functional areas can have a significant impact. As part of the transformation, it is important to meet with the business leaders to define their critical information needs. The business leaders must play a major role in defining the objectives of financial reporting and performance management that help create value. It is also an important time to identify other key stakeholders in the transformation process, including knowledge workers and IT. Also it would not be feasible or desirable to add finance staff to meet new reporting requirements and the CFO should realign within the team for optimum utilization.

With the advent of PE in the ownership reviews of the finance organization and its processes should be conducted by the CFO. It is reasonable to expect that with appropriate process reviews and revisions, efficiencies can be found to expand capacity and free finance resources. During this process, it is also common to identify and eliminate legacy reports that no longer add value and redundant activities. A good example of this is sales reporting performed by both the sales and finance organizations. The rationalization of reporting and processes should take place, and any unnecessary or low value activities should be eliminated. This process will free up numerous resources and allow for a critical review of existing data and reporting. Finally, this is an appropriate time to review the effectiveness of reporting systems, use of spreadsheets and the various finance functions. There may be further opportunities for automated processes, streamlined procedures or outsourced activities. As most PE acquisitions are funded in part by debt, monthly debt covenant compliance reporting will also be required. Additionally, monthly Capex reporting will become the new normal due to the high level of scrutiny. The monthly reporting pack is generally shared by the PE as a part of the transition and gives the CFO the first taste of the PE firm's insatiable appetite for information in the mission to create value. It also becomes the first document that expands monthly reporting well beyond historical financial reporting and the traditional monthly close process. Much of the information that will eventually be required for the monthly reporting pack may not be readily available. Consequently, it is important to commence reporting with well documented information and expand the reporting requirements as processes are realigned and the necessary data and information becomes reliable. The monthly reporting pack is the first document that is used to provide the insights necessary to support the value creation process. Important consideration should be paid to key issues, target exceptions, trends and other forward looking items. When developing the monthly reporting packs, one must identify and include information critical to business leaders in the value creation process. This information will originate in operations, sales, HR and other functional areas of the company. Even sensitive information, such as customer or quality issues, should be included due to their associated risk and cost exposure. The pack may have reporting both in INR and US$ so the appropriate exchange fluctuations and impacts needs to be assessed and implemented. To successfully meet company-wide strategies and create value, it is important to develop fact based measurements that include economic impacts. It is critical that the entire company focuses on a common set of measurements and targets. These measurements are often referred to as Key Performance Indicators (KPIs). It can be difficult to identify what a company's KPIs should be and then find and assimilate the related data. Prior to the advent of PE, promoters may have relied on their experience and knowledge of the company and the industry to make business decisions. With a change in strategic direction, key facts, not intuition, becomes the norm to support business decisions. Key operating facts exist throughout a company and all lead to an impact on the financial statements. Key operating facts in sales and marketing activity can include pricing, sales pipeline facts, closure rates and lead times. Key operating facts in operations can include costs, production or delivery facts, quality issues and scheduling. Employee headcounts and classifications exist in both the functional areas and in HR. It is a very common that key operating facts are not available to the finance organization and that data inconsistencies exist between functional areas of the company. In addition to key operating facts, available data has expanded significantly and exists in many formats. The massive amount of available data has become known as "Big Data." Big Data can be financial or non-financial, internal or external, and it can also come from customers, vendors, operations, sales, employees or advisors. A company can develop a competitive advantage if it carefully selects key data. The data must be timely, relevant and reliable. It also must be comparable and provide the sought after insight. With such a plentiful supply of Big Data, its use needs to be well managed and not abused. There should be single data sets within a company and the most reliable and timely sources identified. Careful consideration needs to be paid to collecting, migrating, cleansing, transforming, and integrating Big Data into a company's performance metrics. This process invariably leads to the realignment of company employees, processes and systems. Effective performance metrics find their way into the planning and budgeting process.

CFO also leads the Technology transformation: IT solutions have an important role in the value creation process, but the decision to select and implement a system should be made after the requirements to support the company's new strategy are determined. The first step in transforming the financial reporting and performance management processes is to identify the data and information required to provide insight and impact decision making. It is critical to survey and prepare an inventory of the data, data sources, systems, processes and reporting required, as better use of IT systems, particularly Enterprise Resource Planning ("ERP") and Customer Relationship Management ("CRM"), can dramatically improve the company's performance. The company should take a balanced approach to transformation, looking at both information needs and business processes. The CFO will also need to implement the use of Business Intelligence ("BI") tools, which can be highly effective.

To summarize CFO's are the unsung heroes for the Financial transformation on the PE investments but the experience gained during this transformation process prepares the CFO for higher responsibilities in terms of Board positions and heading the business with a holistic knowledge and experience of the complete business model.

(The author is Executive Director and Chief Financial Officer, Berggruen Hotels Pvt Ltd.)