Funds. The fundamental need that opens a path for you to dive into the business world. When you have gained sufficient funds, you feel like you are on top of the world. This is it, I got the hang of this, now all I need is to just spend the money on necessities to keep the business active. To tell the truth, utilising funds is way more complicated than just spending them on what you think your business needs. You hear businesses collapsing because of not spending funds the right way. You never imagined seeing your business failing as well just because you deem you are spending money the right way. Well, if I am on the right track, I would be safe from this, right? What is the big deal anyway? Fast forward a few years into your business, you start realising that you are running out of funds. You started selling assets to save your business from closing down. In the beginning, you actually had more than sufficient funds. You had full control of your own money – but were you using it carefully?
Having a highly profitable business is definitely every entrepreneurs’ dream. When you get so much profits, what should you actually do with all those excessive funds? How could you put it back into your business to make your business grow bigger? The goal is to make your business grow, not just remain stagnant in a safe zone with so much money not being utilised correctly. What is the secret for big businesses that have so much cash to generate even more money over time? Using money to make more money – sounds like a great plan for the future of your business, right?
Spending your money comes with a lot of risks linking to it, and this needs to be thoroughly considered. When you engage with a project, money is involved. You may have to fork out a large sum of money and a risk comes with this. As a boss, you are responsible for giving the final word in decision making.
Thus, the risk management process must be mastered by you right at your fingertips. You must know that business itself is all about managing risks. Not just one, nor two, but many risks and you must be clear of the extent of these risks causing an impact to your business. It is a rather general topic, but what exactly do you need to know about risk management?
Pauline is the owner of a dental clinic and is indeed very experienced in this field. She is aware of how large the dental market is and a lot of business profits could be generated just from the dental business. Pauline was in dire need of a new challenge. She was determined to build an empire all by herself and let her business go on an initial public offer (IPO). So, Pauline started raising funds not only for the dental business, but also for other businesses in the medical field and she acquired specialists as well. She knows these businesses could generate huge profits for her that helps her towards her IPO goal.
To her dismay, her efforts of raising funds were not as fruitful as she imagined it to be. Yes, she did expand her business, she built new branches of her dental clinic as well, she even invested in several other small clinics; but after further calculation, she found out that the return on equity (ROE) was at a low of only 17.72%! Her efforts were all not worth it at all! Pauline started freaking out because she cannot achieve her IPO target soon enough. She encountered so many problems in the entire process of building her empire. Buying assets? To rent or to buy? There are just so many decisions to be made, and it is not as simple as kickstarting the operations of her dental clinic in the beginning.
She did have a CFO when she was pursuing her efforts in expanding her business, but he was not as helpful as he was inexperienced in this matter. He did not help Pauline in making decisions on where the extra cash in Pauline’s hands should be invested in. Ends up, the money was invested in places not within her business. Pauline needed a better person to manage her business, so she restructured her organisation and appointed a new, more experienced CFO and made the existing CFO her COO. With the new CFO’s presence in Pauline’s organisation, she learnt more about managing her money as the new CFO was very well-versed in management accounting and helping bosses manage their money.
Overall, having all the knowledge regarding risk management is a very important job scope of a CFO. As a boss, you may not know about risk management in-depth, all you know is that you have money and you want to spend it. This is why you need a CFO to guide you through the entire process of spending your money so that you do not end up jeopardising your own businesses just because you did not spend your money on something carefully. You do need to pay attention to four areas in this case, i.e. risk management, acquisition of assets, value investment, and business acquisition strategy.
Generally, risk management is a procedure for businesses to identify, assess, and then treat the risks that will pose an adverse impact to the business’ operations. A risk is harmful to businesses because they could potentially lead you to losses. However, the type of risk and the level of impact of these risks do vary from one business to another. Some examples of common business risks include strategic, compliance, financial, operational, environmental, reputational, security, and even technology risks. A CFO will guide you in developing a proper risk management plan so that you know how you could prevent these risks from occurring. A risk management plan consists of four steps: risk identification, risk assessment, risk management, and lastly, monitoring and review. The CFO will conduct various types of analysis or even use ratios to determine the level of risk your business is facing. This will be further discussed in the later part of this writeup.
Acquisition of assets
When acquiring assets, you need to consider which is the most beneficial for your business in terms of ownership and financial outflow. Should you borrow the asset? Or just rent it? How about buying it with cash directly? Do you have enough money for you to undertake such a decision? How much control do you have over the asset? What are the pros and cons that come with each decision? It all depends on where your business is planning to head towards, especially when it comes to the recognition of these on your business’ balance sheet. It will result in different valuations of your company.
You got all the money. You are interested in investing your money in shares. Hence, beginning with the end value in mind, you must know how much you are willing to invest and the investment must be valuable enough so that you get the returns you deserve. Don’t just invest because you hear people saying it is worth investing in. Do your own calculations to have a clearer view on whether the investment brings value to you. There is a formula for that and it is simpler than you think!
Business acquisition strategy
In expanding your empire, you may start showing interest in acquiring other businesses or even merging your business with theirs. This is simply known as the mergers and acquisitions strategy (M&A Strategy). When you have so much money, you might want to purchase all the shares in a company to gain full control over that company.By serving a larger customer base, acquiring other business helps your business make even more money and. It is the fast track in growing your business. You, however, need to be clear that not all businesses are suitable to be acquired by you. There are risks to this too, and acquiring the wrong business may lead you to suffer losses, because a subsidiary’s losses will book into your holding company.
Now, let’s see how you could make better decisions on how you could spend your money or funds carefully. Just like above, I am going to break it down into four major sections.
Firstly, you need to be fully clear of the purpose of risk management, i.e. measuring the potential outcomes of the risk to help you make better business decisions that will prevent you from suffering losses, especially financially. Identifying risks may be easy, but the tricky part is by deciding how impactful these risks are. It will be a good practice for you to combine both financial and non-financial analysis to help you determine the extent of impact of these risks.
Debt-to-Equity Ratio = Debt / Equity
You must always monitor your business’ debt-to-equity ratio as this shows the proportion of debt versus equity your business is using to finance all of its assets. It is also an indication of whether the shareholders’ could still get their returns when the business is not performing well. When the debt exceeds the equity funding of a business, it may be an indication that the business is facing a higher risk of bankruptcy. From the debt-to-equity ratio, you can start determining the risks your business may face, mostly being financial risks, and the ways to mitigate these risks.
Break Even Analysis
Break Even Point = Fixed Costs / Gross Profit Margin
Break even is the point where the total cost and total revenue of your business are equivalent to one another. In this case, no gains or losses are being made. Once your business goes below the break even point, it may be a warning sign that your business is not performing well financially and puts you at risk. So, conduct a break even analysis to identify the exact amount of revenue needed to cover your total costs and slowly work your way upwards to go ahead of the break even point, so that you will have more money to invest in the future. The break even analysis is widely used in projects, outlet units, franchisee branches, events and team developments.
Sensitivity analysis is done to determine how different values of an independent variable would affect another variable. In other words, how much change could the business take before it causes a loss to the business? In determining risks, you should conduct this analysis to determine the worst case scenario that must be avoided in the future from threatening your business. There is no exact formula for this analysis as it is all a matter of playing around with the figures and studying its changes. It would be creating just three scenarios to compare with one another.
The PESTEL analysis is done to study the macro environmental factors that affect your business. Identifying the threats and weaknesses just like the SWOT analysis in Blog Having an Analytic View of Your Profit with SWOT
, the PESTEL analysis focuses on six key areas: the Political, Economic, Social, Technological, Environmental, and Legal environments. This could even be used together with the SWOT analysis to strengthen your risk management process. With all of these risks being identified, your business can proceed to determine what risks to constantly keep an eye on and how certain costs could be cut down so that you can maximise your revenue.
Acquisition of assets
In reality, businesses seldom purchase outright assets unless they are certain that the purchase is fully beneficial to the business. This is because assets tend to be upgraded over time, and purchasing outright would cause businesses to suffer from being a step behind technology-wise. If they want to purchase a new asset, more money needs to be forked out and at the same time, selling the older asset would be far more difficult compared to when it was new.
So, businesses tend to decide between going for a financial lease or an operating lease, or, to put it in simpler terms: to borrow or to rent? If you opt to borrow (financial lease), your debts will be shown in your books as liabilities, and this may be a bit less favourable for your business. On the other hand, renting (operating lease), is more of a contract and in contrast to borrowing, the figures will not be shown in your books. The costs of financing these two decisions will differ from one another, so you need to know which one brings the best benefit to your business.
However, there is a catch to this. Due to the introduction of IFRS 16, a single lessee accounting model is introduced whereby financial and operating leases are no longer differentiated from one another. Every lease will be considered as a finance lease providing that they are leased for a period of more than 12 months and costs more than RM5,000. So, let’s say your company is leasing a photostat machine costing more than RM5,000 for over a year, you need to recognise this asset in your books even though you are financing this asset on a monthly basis. Of course, there is a way for you to hide this figure in your books but there is no way for you to hide the risk you need to bear. If you do not pay the lease, you are still liable anyway because you are tied to a contract; therefore the lessor can still charge you for the outstanding amount and in the worst case scenario, they can pull the asset from you, just like in the case of hire purchase.
Having money is a strong advantage to you as you could use it to make even more money. One of the most common methods is by investing the money in shares. You begin with the end value in mind. Know how much the future value of your investment will be before making your investment. Without sufficient knowledge, when you make a decision, you tend to invest based on the wrong analysis done by other people, causing some investments to be undervalued based on wrong information. Here, we can use a formula established by Steven Penman to determine the future book value of an investment:
Future Book Value = Current Book Value + Future Earning - Future Dividends
With this formula, you would be able to predict if the investment would be undervalued in the future. You do not want to waste your money on an investment that does not have any value in the future. Your goal is to invest in a business that grows so that your returns will grow too. You could also determine the future value of the business as follows:
Future Value of a business = Current book value + Short-term value creation + Long-term value creation
Business acquisition strategy
The M&A strategy does sound like a rather straightforward process when your aim is to grow your income and expand your market share. It is also a method for you to strengthen your position in the market when you opt to take over your competitors. “if you cant compete with them, buy them” just like how Facebook bought over Instagram. Of course, a lot of money needs to be forked out and it is important for you to consider the risks that come with your M&A decision. However, you strategize your move by offering them your shares instead of cash. One of the biggest risks is the miscalculation in the valuation of assets which will affect you financially. You must make sure that the amount you are paying to make the M&A process happen is relevant with what you will be getting in the future from this strategy. You must also be aware of the risk of differences in culture, e.g. whether their business culture is in line with your core values. You have to consider these perspectives before simply merging or acquiring another business because turning back would be a difficult process once the decision has been finalised.
Being in charge of such a huge amount of money definitely makes using a portion of those funds for your personal funds very tempting. However, as a boss that is funded by investors, you must be ethical or you have to suffer the consequences in the future. The misuse of funds will result in a criminal breach of trust, and malpractice or misconduct of the director may pay a hefty price. When your business’ money is not spent ethically, whereby it goes to unidentified sources, you trigger your stakeholders to complain against you. In some scenarios, tax authorities will begin an investigation to see if there is any tax evasion by you. If you are found to be guilty, you will suffer even more financial losses as you will need to bear penalties charged by the authorities or worse, jail term
Your personal growth is indeed just as important as your business growth. I have seen a lot of bosses not treating the SME as a separate entity, where they tend to take money from the business for their personal or own retirement purposes. This is unethical and may be one of the reasons why such businesses tend to collapse within a few years. When there is a will, there is a way. You want to create your own wealth? There is a proper way to achieve that.
With the extensive knowledge on risk management, Pauline realised that not all companies are capable of giving her the revenue she aims to achieve. She has been wrongly investing in small companies that are not established enough to be generating sufficient profits in the industry. So, with the CFO’s help, Pauline drastically changed her strategy. She studied then bought over companies with better revenue, as well as companies that are older with not much profit but are strongly customer-based. As a result of this new strategy, the revenue generated from her investments in other businesses increased by twofold. Her effective M&A Strategy has successfully resulted in larger revenue, the businesses have a higher valuation, and finally buying profits into her holding company, Pauline achieved her dreams of going on an IPO by looking at a larger revenue stream and profit diversity. Pauline feels truly satisfied after all the hardships as her business is finally on an IPO.