DRAWING MEANING FROM YOUR FINANCIAL$

by Bukhosibenkosi H Moyo

Every CEO has a vision to drive his / her company forward, and every CEO doesn’t want the ship to hit an iceberg under his / her watch. Never. As a result, the CEO spends valuable time in briefings, in meetings and in workshops. He allows for an amazingly huge budget for annual strategic planning sessions. Sadly, notwithstanding the effort, company performance sometimes goes down embarrassingly. And the buck stops with the CEO. The CEO then has the unenviable task of facing seemingly ruthless shareholders to explain why performance dipped. In many such scenarios, many CEOs have paid with their contracts. Sad. But it need not be. There lies, within the very reach of the CEO, and within his imputed rights, a powerful communication tool that can shed more light into the operations of the business than any strategic planning session can. The financial statements.

The financial statements are composed of the statements of financial activity, financial position, cash flows, changes in owners’ equity and the notes thereof. When they have been properly prepared (that is, prepared in accordance with an appropriate financial reporting framework such as

IFRS, IAS, IPSAS), they provide company leadership at all levels including the apex, with valuable information that can lead to change of long term strategy. Whilst other non financial information is critical, such as market information and technological changes, the bigger and clearer picture is told by the financials. Without reducing the boss to a bogged down number cruncher, the financials provide a good snap shot of past, present and future performance, and affords valuable opportunity to plan for this future. Having analysed the financials, strategy can be amended to keep the ship afloat. Many CEOs are Chartered Accountants and would therefore have no problem in understanding financials. But for the sake of those from outside the numbers professions, here is what you should ask for and use.

Ratio Analysis Gone are the days when the CEO was only interested in the ‘top line’ – the revenue, and the ‘bottom line’ – the profits. There is so much more. As an example, if the company were to invoice USD5 billion to a huge customer, who is set to pay off ‘later’, the financials will have a handsome top line and an even cuter bottom line. But there is a risk that the USD5 billion may be uncollectible.

A CEO who looks only at the top and bottom lines will have a wrong picture altogether. However, further analysis can show the correct picture. To the CEO, the FD should present a pre defined set of ratios, that summarise the financials. Ratios are classified into four distinct groups, namely liquidity ratios, profitability ratios, efficiency ratios and gearing ratios. These are so designed to analyse the financial statements in full and CEOs should be trained in the analysis.

Efficiency ratios, for example, include some asset utilization ratios that show how much revenue you are generating from your investment in noncurrent assets. These assets are by their very nature meant to generate income for you. But have they? It could be that the heavy investment in plant has not yielded the expected proportionate increase in revenue. The ratios will say and you may decide on what corrective action to take. Liquidity ratios are designed to gauge your immediate ability to pay off short term obligations. You will agree that it is embarrassing to realize that by the 10th of April you are just unable to remit PAYE for March. So much from a learned and experienced CEO! Be on the lookout for these tell-tale signs of trouble. Check your liquidity ratios regularly, because when they are left unguarded, technical insolvency is on the way. If you have long term loans, or debt instruments such as debentures, keep them under check. Gearing ratios help to show if your borrowings is getting out of hand. If you are to avoid handing the organization to the vultures, keep an eye on gearing. Profitability ratios measure the value of profit. We’ve made a profit, so what? Is it at the right levels? Profitability ratios such as Return on Capital Employed (ROCE) measure the return on the capital that has been invested into the business. The profit maybe a good dollar value but it may actually be a negative return on capital. These ratios will help the top boss to see if performance is still at levels that meet the shareholders’ requirements. It will be a pleasure to present such a report at an AGM! There are many ratios under these four categories and they all help to connect the different facets of the financial statements so as to give the CEO a quick bird’s eye view of the financial performance of the business, as well as to show the areas that need attention. It will also help the CEO not to come down hard unnecessarily on the Marketing Department when sales are low because the ratios may show that the low sales are due to reduced noncurrent assets.

Trend Analysis This year’s ratios look good… but wait a minute! What were they like last year? And the year before? It is very useful to do a trend analysis of not only performance, but also of analysis tools such as ratios. When performance is compared from one year to another, the trends may paint either an interesting or worrisome picture. The same is true for ratios. When compared against each other, they may reveal decreasing efficiency which, when noticed, can be then handled appropriately. For a CEO with a busy schedule, these trends can be pictorially presented in graphs and meaningful charts. The FD must be able to effortlessly feed these to the CEO regularly. However, trends should be viewed in the light of PESTEL issues so that they are not misinterpreted. This means that lower than average performance may have been due to a general slump in the economy, whilst actual asset utilization could have improved.

Z Score Designed by Edward Altman in 1968, the Z score , a simple combination of weighted financial ratios, can tell the CEO if the company is heading towards bankruptcy or not. Empirical studies done reported that the

Z Score is able to give a bankruptcy warning even two years before the actual closure. If such a picture is shown timely, the CEO can urge the board to re strategise and avert failure. The Z score is easily calculated, and if the FD is worth his salt, he knows how to calculate and interpret it. As CEO, ask for it, demand it. You need to be always well informed of where you are going. While the Z Score may not predict business failure caused by fraudulent activities (as in the popular Enron case), it sure can tell you if your business model and financial position is leading you to the abyss. Many companies found themselves closing ‘without notice’. Whilst a good number closed due to increasingly unfavourable macro economic fundamentals, many met their fate because early warning signs were ignored.

So, there you have it. Your financials, presented to you in full or in summary or by way of analysis, will help you to steer the ship to a safe harbor, where your shareholders will be eagerly waiting for you to dock.

And if you arrive safely, your stay in office is guaranteed