The numbers game – How important are they?

 

 

Running a business, whether, medium or large, is a complex task. Proper financial management is key for a company’s survival and growth. A decent financial management system requires a combination of at least three ingredients: reliable people, bulletproof processes and most importantly a CEO and board that understand the importance of a good finance function.

 

One major roadblock to this is whether the top management can get the right combination, which depends a lot on the importance given to finance by the Board, the CEO and other C-level executives. If they think it is critical enough, they will then hire competent people, put in place the required processes and give the finance team the scope, autonomy, respect and trust needed to make this vital function effective. What does that mean? In the Middle East, finance is backward in many companies. CEOs perceive finance as a mere support function that keeps the books, pay the suppliers and collects from the customers. This attitude is not ideal for any business.

 

World over the CFO function is seeing a transformation where the role is not just about accounting and reporting but also advising the CEO and the board on strategy (financial, operations, sales etc.).

 

However, that does not mean the CFO should ignore accounting and reporting which still found the core of his work. There comes a time in every business when the founders’ cash has run out and they desperately need money to expand their business or secure working capital. Hence, they would need other investors. Financials are essential if you want to attract investors. The reason is simple; you can claim to be the fastest growing, most profitable, most efficient, most liquid, and most cash flow positive entity on this planet but these claims mean nothing if you can’t produce decent financial statements to back these up. 

Investors want to see the reality of what happened before they put their money in, and reality is best captured in independently audited financial statements. Thus, get the basics right and make sure your systems and processes can produce accurate, complete and timely financials. It is important to remember that the investor will not be typically involved in the business. However, he will rely on the financials to know what is going on or what is right and wrong. Hence, if you do this right, you may even get a higher price for whatever stake you are selling because the investor knows he can trust the numbers in the future.

 

The related query is what numbers do investors want to see. Different investors have different objectives in buying shares of your company.

Angel and private equity investors want an exit strategy. Hence, they want to see the business growing in 5-7 years so they can sell their stake for a good profit. They want to see steadily rising sales and cash flows. A small investor in a big company may just want to buy and sell his shares quickly for a profit on the local stock exchange. In that case, he may not be concerned about the financial statements. He would be interested in the stock price, past price trends and the price to earnings ratio; all of which indicate whether the stock is overvalued or undervalued and when is the best time to buy or sell.  Another small investor may have a long-term view and hence will be more interested in annual profits, cash flows and the effect on the share price. However, investors of all hues and colors hate to see a company racking up consistent losses (i.e. negative net income) and bleeding money (i.e. negative cash flow from operations).  Also generally, investors do not like to see big fluctuations in sales, profits and cash flows unless there are crucial reasons like a global recession! Additionally, investors are not thrilled with a company that has too much debt, as evidenced by, say, the Debt to Equity Ratio - the more leveraged a company, the more risky it gets for an investor.

 

Therefore, not only profit has to be analyzed but revenues, cash flows, debt levels, and the share price also have to be taken into account. Certainly, financial numbers are only part of the story. An investor tries to build a convincing story about a company based on the economy, the industry as well as the company’s management.  Nevertheless, the financial statements are a crucial part of that story.

 

 

About Binod Shankar

Binod Shankar is Managing Director and Trainer at Genesis Institute. In his role, he has delivered presentations focused on the SME sector covering topics such as budgeting, cash flow management and financial control.

Binod started his career in an industrial bank in India. He then spent six years executing audit, financial due diligence, financial feasibility and valuation assignments with KPMG, Arthur Andersen and Ernst & Young in Oman and Dubai before joining Nakheel. He was also the Executive Director-Finance at Gulf Finance House in Bahrain. Binod has been teaching advanced finance and accounting courses since 1996.

Binod is a Chartered Accountant and a CFA® charterholder.

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