Executive Finance and Strategy

How to Understand and Use Financial

Information to Set Strategic Goals
Ralph Tiffin
Kogan Page 2014
344 pages
[@] getab.li/23071
Book:

Rating

8 Applicability
6 Innovation
6 Style

Focus
Leadership & Management
Strategy
Sales & Marketing
Finance
Human Resources
IT, Production & Logistics
Career & Self-Development
Small Business
Economics & Politics
Industries
Global Business

Take-Aways
Executives with a clear understanding of their companys finances and of accounting
procedures have a better chance of executing their strategies.

An operational financial strategy uses models and measures to plan and report

information about relevant variables such as profits, efficiencies and cost reductions.

A structural financial strategy focuses on tactics for financing a business efficiently.

All business strategies depend on cash flows.
Producing shareholder value is not a strategy; it is the result of executing a strategy.
Companies with high gearing or leverage ratios in excess of 40% to 50% should
consider themselves bank-owned, not shareholder-owned.

Auditing rules assure consistency and curtail erroneous and bad accounting practices.
For many businesses, developing a budget can also create an adequate strategic plan.
The return on investment, the profit margin and the asset utilization ratio are critical to
proper ratio analysis.

Capital cash flows, such as expenditures on fixed assets, result from longer-term
activities as opposed to regular operations.

Concepts & Trends

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Relevance

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What You Will Learn
In this summary, you will learn:r1) How financial decisions affect a company; 2) How certain important ratios and
reports indicate a businesss strategy; and 3) How to use financial data to analyze risks, opportunities and operations.
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Review
Financial strategy is a critical part of running any business. Nonfinancial managers, board members and executives
must understand how this strategy improves their overall operations. Auditor and consultant Ralph Tiffins manual
complete with tables, case studies, accounting examples and definitions addresses UK accounting rules more than
US accounting standards, but is useful in either market. He offers solid strategic information that enables managers
to see the impact of their firms strategy, behavior and ethics as reflected in its financial documents. Tiffins measured
style can be dry and sometimes heavy going, but getAbstract recommends his basic compilation to nonfinancial
managers and executives seeking full access to the valuable information inside corporate financial reports.
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Summary

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Understanding
financial statements,
concepts and
conventions is a
necessity if we are to
know where we are
[and] how we got
there and as a base for
projecting where we
might be.
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An executive must
ensure that the
organization is able to
meet its obligations as
they mature.
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Strategic Accounting
Companies use accounting to plan, implement and monitor their business strategies.
Modeling and financial reporting are tools for developing policies and pursuing profits.
Accurate bookkeeping and accounting provide a verifiable way for executives to ascertain
the assets under their companys management and to make sure that they fulfill their
responsibility to investors. The companys accountants and the finance director are
responsible for ensuring precise records, safeguarding assets and limiting liabilities. They
report financial results to senior executives and the board. Top management is responsible
for understanding the information and executing the firms strategy.
A financial strategy is a plan to use assets and liabilities to achieve corporate goals. A sound
strategy has a quantitative aspect. Accountants provide data to show managers changes in
costs, income, profits, net assets and cash flows all of which indicate a strategys direction
and status. A company can manage its strategy with an operational approach or a structural
approach. An operational financial strategy uses models and measures to plan and report
data about fiscal variables such as profits, efficiencies and cost reductions. A structural
financial strategy focuses on efficiently financing the business.
A mission statement explaining a companys core purpose communicates these strategies.
This statement identifies the firms audience, states what products or services it delivers,
and explains why the corporation or its offerings are unique.
From a financial perspective, strategy helps improve profits and reveals the strategic
utilization of capital, manufacturing assets and equipment. These reports indicate the
amounts of working capital, inventories, receivables, debt and leverage. Compiled in
strategically structured financial statements, these reports also reflect business operations.
Return on Investment
Any business must focus on its return on investment (ROI) or return on capital employed
(ROCE). These indicators show the companys success in meeting goals that produce

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shareholder value, increase free cash flow over time to pay dividends, and build earnings
and share price. Producing shareholder value is not a strategy; it is the result of executing
a strategy.
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Business strategy
is nothing without
finance; finance binds
the business and a
business is bound by
finance.
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Finance is at the
heart of any business
businesses would
not exist without the
pumping of cash
through the business
and the consequent
recording of the flows.
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ROI reflects the operating profit from normal operations before taxes and interest, divided
by the capital used to produce the profit ROI is profit over capital employed. It partly
derives from the income statement, which shows net income from sales over a set time,
minus costs.
The category of capital employed can be seen from two perspectives: as the net amount
of the firms assets and liabilities, or as the money invested in the company in shareholder
capital. This can be an investment in cash or stock, as well as previous profits reinvested
each year, plus bank loans. High profits and sales drive ROI, which can be affected by
idle assets.
Reports on cash flow indicate a businesss ability to generate future net cash, as well as
its borrowing levels, spending patterns, dividend payments and cash outlays to investors.
A cash flow analysis matches profit and net cash inflows with losses accompanying net
cash outflows. The P&L shows sales minus costs for a specific time. Profit is income
over expenses. Income encompasses revenues and gains, including unrealized gains from
the appreciation of long-term assets. Expenses include losses and regular payments for
ordinary operations.
Truth and Fairness
Senior managers with oversight responsibilities have a fiduciary duty to be sure that
financial accounts correctly represent company operations. Most accounting functions
are computerized, so correctly categorized and compiled data should produce accurate
statements. Firms must follow accounting standards, provide ethics training and adhere to
corporate governance policies.

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The aim of
bookkeeping is to
ensure that figures are
complete and as free
from error as possible.
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According to UK accounting standards as specified in the Company Act of 2006

companies must keep precise records that show transactions, daily income and
expenditures. The law requires firms to promote fair conduct and maintain business
standards. Their directors must make long-term decisions in the interests of shareholders,
vendors, the environment, the community and their employees. The Act mandates that
executives use independent judgment with reasonable care, skill and diligence, and that
they avoid conflicts of interest.
UK Strategic Reports
In the UK, the document known as the strategic report consists of these areas:

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The main difference
between profit and cash
flow is the accruals
concept, on which most
financial reporting is
based.
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Assets Cash, sales agreements or real property, like buildings.

Liabilities Money owed to others or invested by shareholders as share capital and
categorized as credit balances.
Income, sales or revenue The sum of all sales. Recorded sales show as increased
assets either as cash received or as a debt owed to the company. Debtor balances are
classed as assets.
Expenses, purchases and overhead Costs or debits for salaries, goods or services.
A purchase produces a decrease in cash or an increase in liabilities. Debit and credit
balances are the elements of bookkeeping, P&L and balance sheet reports.

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Spreadsheet
analysis of investment
opportunities prior
to commitment is an
obvious way to identify
and eliminate risk.
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The future economic
benefit of an asset is its
potential to contribute,
directly or indirectly,
to the flow of cash and
cash equivalents to the
entity.
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The Power of Audits

Internal auditors or independent, authorized auditors report to executives and shareholders
to tell them whether a companys accounts comply with the Companies Act. When a
company undergoes an audit in the UK, it receives a report stating the framework of
the audit, the responsibilities of the companys directors, and the scope of the financial
statement audit, including any incorrect data and how it affected the original report. The
auditors evaluate whether the financial statements comply with accounting results and
whether they adhere to the law, the International Financial Reporting Standards (IFRS) and
EU standards.
Accounting Theory in Practice
The balance sheet reflects accounting practices, including the categorization of assets,
liabilities, revenues as well as other elements. Having this documentation benefits
managers who must plan and run the financial side of their businesses, a task thats
become increasingly difficult, because modern business procedures inject qualitative and
classification issues into accounting. Financial statements, or general purpose financial
reports, help investors and other creditors make more informed decisions about a
companys financial health.
Financial statements are public information. Interested parties can view a firms business
models, performance and risk exposures. The UKs Generally Accepted Accounting
Principles (GAAP) and IFRS GAAP specify what financial statements must include, such
as data that indicate a companys future cash flows, timing and certainty. Additional
information comes in directors reports that list board members, their shareholdings and
other material facts not found in accounting reports.
In the US, regulators rely on 10-K statements to summarize a firms activities. The annual
report publishes these data and links income and expenses to company performance; it also
reflects income and profit or loss, which determines ROI and earnings per share.

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Accounting theory
and rules affect the
strategic numbers
and therefore affect
underlying tactics.
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The UK summary document the strategic report includes earnings before interest,
taxes, depreciation, amortization, and rental expenses (EBITAR); earnings before income,
tax, depreciation and amortization (EBITDA); operating profits before tax; nonrecurring
income and net profits or losses; earnings per share (EPS); and the ordinary dividend
per share.
Understanding the Numbers
Executives who want to interpret financial statements correctly should study what the
numbers indicate about day-to-day tactics and long-term strategies. With this information,
they can redirect a companys plans, if necessary, to make it more profitable.

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There are financial
strategies that deliver
more by optimizing
financial (balance
sheet) structure rather
than operational
performance.
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Ratio analysis can include benchmarking competitors, analyzing relationships and

comparing past performance to budgeted performance. Executives should be cautious about
drawing inferences that are not contained in the numbers. Pitfalls include making faulty
extrapolations, examining a too-short time frame, citing gross numbers or injecting personal
prejudices. The most important ratios to analyze are ROI, the profit margin (operating profit
to revenue) and the asset utilization ratio (revenue to capital employed). These measures
vary widely, based on a company, its headquarters location and industry. For instance,
construction firms would find a 10% profit margin high, while a virtual company, with
few assets and an outsourced labor force, could have a high asset utilization ratio.

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In judging working capital, executives should understand the current ration and the liquidity
ratio, which gauge a firms capacity to satisfy its obligations, and the gearing ratio, which
measures leverage. The current ratio divides assets cash and assets that will convert into
cash within a year by liabilities. The liquidity ratio excludes inventories and works in
progress from current assets, since these items dont quickly turn into cash. Its an acid
test of a companys ability to pay its liabilities as they occur.
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The budget process
is the key tool or tactic
to be used to deliver
operational strategy.
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The gearing ratio enumerates long-term loans or nonrecurring liabilities over shareholder
funds and long-term loans. Companies with high gearing ratios in excess of 40% to 50%
should consider themselves bank-owned, not shareholder-owned. Normal gearing ratios
are 20% to 40% and indicate a consistent loan repayment cycle.
Cash Is King
All business strategies depend on cash flows. Cash or working capital is a current asset
on the balance sheet. Analyzing cash flows depends on the companys strategic goals,
tactics and trading conditions. Important inputs include the timing of various outstanding
receivables and the number of suppliers waiting to be paid. This analysis often raises issues
of delaying payments to vendors and having a viable growth strategy.

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The drivers of
return are...good
margins, lower costs,
higher sales and wise
investment.
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Worldwide, there are
moves to make financial
statements even more
useful and not just to
investors for making
economic decisions
but also useful to all
stakeholders.
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Capital cash flows result from longer-term activities as opposed to regular operations. These
can include expenditures on fixed assets and borrowed money. Cash flow data show changes
in net assets, liquidity, solvency, and a firms ability to raise cash and cash equivalents.
These figures are important when compared to a firms expenses as part of assessing
its working capital cycle. Examining a companys consolidated statement of cash flows
indicates whether it is profitable and can generate cash from consistent depreciation and
other noncash actions. Capital expenditures should be consistent and a little higher than
depreciation. This reveals whether a company is preserving its operating abilities, what
acquisitions it has made, what restructuring has occurred and what dividends it has paid.
Management Accounting and Budgeting
In the UK, management accounting is the practice of building value in a private or public
sector business. Listed companies present their models in their strategic reports and show
how their businesses will build and maintain value over time. The link between financial
strategy and management accounting is evident in the historic data. The older data patterns
show whether a strategy worked and what it produced.
Budgeting is essential to implementing an operational strategy. For many businesses, just
developing a budget produces an adequate strategic plan. Companies can develop budgets
two ways: The incremental or traditional approach uses last years budget and adjusts it
to current conditions. The zero-based approach to budgeting determines what costs are
necessary, what resources are needed to achieve the firms goals and whether this is the
optimal use of resources. Using these tools, managers and directors can understand their
firms fiscal goals and assess whether they are realistic. Then, executives must clarify how
the firm will reach its objectives.

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About the Author

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Ralph Tiffin is principal of McLachlan + Tiffin, an auditing firm, and director of Tiffins.com, a training and
consulting company.
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