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Slide Deck 2. Communicating with CFOs Microsoft Sales Pilot Program January 6-7, 2009. Tony Dimnik, PhD tdimnik@business.queensu.ca. CFO Concerns. Impact of global economic conditions on Finance/IT Financial crisis → conserve cash and reduce costs

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communicating with cfos microsoft sales pilot program january 6 7 2009

Slide Deck 2

Communicating with CFOsMicrosoft Sales Pilot ProgramJanuary 6-7, 2009

Tony Dimnik, PhD

tdimnik@business.queensu.ca

cfo concerns
CFO Concerns
  • Impact of global economic conditions on Finance/IT
    • Financial crisis → conserve cash and reduce costs
    • Volume and velocity of information → simplify
    • Competition → develop strategic advantages
  • Environmental pressures
    • Limits to growth
    • Continuous improvement
today s agenda
Today’s Agenda
  • Introductions
  • Objectives – Pilot Program (Fire, Ready, Aim)
  • Finance issues
    • Language and tools
    • CFO concerns
    • Organizational structure
  • Fundamentals of Financial Accounting - QT
  • Costing – allocations and drivers

Decision making tools

  • Strategy and finance
    • Shareholder value
    • Control
  • Selling to the Finance Department
decision making tools

Decision-Making Tools

Multi-attribute Model

Cost-Volume Profit Model (CVP)

Discounted Cash Flow Model (DCF)

investment process increasing use of analytical models
Investment ProcessIncreasing Use of Analytical Models
  • Models aid in decision-making
    • Reduces complexity by identifying key variables and the relationships amongst those variables
    • Involves cross-functional teams (e.g. CIO and CFO/Controller)
    • Generates "answers" sufficient for action
  • Organization-wide use of common models helps justify decisions
    • Persuasion and commitment
    • Checks and balances
three types of decision making models
Three Types of Decision-Making Models
  • Multi-attribute models
    • Listing and weighting of key characteristics
    • Scoring through consensus or means
    • Useful for selecting amongst implementation alternatives
  • Accounting models
    • Profit and balance sheet focus (e.g. CVP, ROI, ROA)
    • Short-term
  • Time value of money models
    • Cash flow focus (e.g. DCF)
    • Life cycle
example of multi attribute model
Example of Multi-Attribute Model

What are the implications for sales?

fixed and variable costs cvp model
Fixed and Variable Costs – CVP Model
  • Set up examples with simple numbers
  • Play around with the examples
  • Understand the concepts
  • Apply the concepts to more complex situations
anyco
ANYCO
  • $5 selling price for each widget
  • $2 for materials, direct labour, packaging and shipping for each widget
  • $10 per year for rent of facility and manager’s salary

How many widgets do we have to sell this year to cover all of our costs? What is the break-even?

What is the profit at sales of 10 units?

cvp basic break even
CVP – Basic Break-Even

Unit Sales

Needed to

Break-Even

Fixed Costs

=

Contribution Margin

Per Unit

using the cvp model
Using the CVP Model
  • Strategic issues (fixed or variable cost structure)
    • Fixed cost is better when volumes increasing (growth)
    • Variable cost reduces risk (major motivation for outsourcing)
  • How does this relate to current business environment?
  • Tactical decisions (five levers of profit)
    • Price
    • Variable cost
    • Fixed cost
    • Mix
    • Volume
  • How can you push each lever?
slide21

DCF is a Key Decision-Making Model

  • Underlies shareholder value (cash flow)
  • Can be used for post-investment audit (and learning)
  • Encourages strategic thinking by addressing structural cost drivers of investments (life cycle costs)
life cycle cost patterns
Life Cycle Cost Patterns

100%

Committed Costs

Cash/Accounting Costs

Investment Life Cycle Costs

Plan R&D Design Launch Market & Support

0%

100%

Investment Life Cycle

an example to help you understand npv and irr
An Example to Help You Understand NPV and IRR
  • Assume you put $1,000 in a savings account in a bank
  • Assume you get $100 interest every year
  • Assume you withdraw the interest
  • Assume you withdraw the $1,000 at the end of five years

What is the rate of return of this investment?

calculate the net present value npv of your savings account using discount rates of 5 10 and 15

Calculate the Net Present Value (NPV) of your savings account usingdiscount rates of 5%, 10%, and 15%

start with the timeline
Start with the Timeline
  • Single most important contribution to decisions
  • Estimate nominal dollars
  • Use timeline presentation format
  • Draw separate timelines for each alternative
  • Numbers are like motions for voting
  • Use team meetings to refine the numbers (like amending motions for voting)
internal rate of return irr and npv
Internal Rate of Return (IRR) and NPV
  • If the NPV is positive then the IRR of the project is higher than the discount rate used
  • If the NPV is negative then the IRR of the project is lower than the discount rate used
  • If the NPV is zero then the IRR is equal to the discount rate used
  • The IRR is the discount rate that makes the NPV of a project equal to zero
  • What discount rate should you use?How high should an IRR be?
setting the discount rate wacc hurdle rate
Setting the Discount Rate(WACC, Hurdle Rate)

Investment

Pot O' Money

Equity

Debt

beta is measure of volatility
Beta is Measure of Volatility

If this is relevant to you, ask for Digressions into Finance.

wacc and hurdle rate
WACC and Hurdle Rate
  • WACC is the Weighted Average Cost of Capital
  • Hurdle Rate is the discount rate used to evaluate investment proposals
    • If you use the hurdle rate to calculate the NPV of a project and the NPV is positive, the project has "jumped over" the hurdle
    • If you calculate the IRR of a project and the IRR exceeds the hurdle rate, the project has "jumped over" the hurdle
  • The Hurdle Rate is usually a few points higher than the WACC (e.g. if a company has a WACC of 12%, the hurdle rate might be set at 15%)
dodie 2000
Dodie 2000

Kris Ashar, managing partner of an insurance brokerage, was thinking of buying a $100,000 Customer Relationship Management (CRM) system, the Dodie 2000. Table One shows the expected increase in cash flows due to the improvements in customer service of the Dodie 2000 over a period of four years. Kris was advised to use straight-line depreciation for the system for both financial accounting and tax purposes and assumed there would be no residual value for the system.

Question

Assuming a 40% tax rate, and a required after-tax return of 10%, should Kris buy the Dodie 2000? Calculate the Net Present Value (NPV), the Internal Rate of Return (IRR), and the payback of the Dodie 2000.

Table One

three other dcf issues
Three Other DCF Issues
  • Sensitivity Analysis
    • Best case
    • Worst case
    • Most likely case
    • Critical variables
  • Assumptions of the Status Quo
  • Dealing with the unquantifiable
assumption of the status quo
Assumption of the Status Quo

Estimated Flows With Investment

Net Cash Flows

Assumed Status Quo

Years

the reality of declining cash flows
The Reality of Declining Cash Flows

Estimated Flows With Investment

Net Cash Flows

Actual "Status Quo"

Years

true differential cash flows
True Differential Cash Flows

Net Cash Flows

Cash Flow Missing From

Status Quo Assumption

Years

status quo questions
Status Quo Questions
  • What will happen if we invest?
  • What will happen if we do not invest?
  • What will happen if our competitors invest?
quantifying what you can
Quantifying What You Can
  • Calculate NPV with all the "hard" numbers
  • Identify all the unquantified benefits
  • A positive NPV represents the lower range of the "real" NPV
  • A negative NPV represents the investment required to achieve the unquantified benefits (i.e. the cost of the unquantified benefits)
example of quantifying what you can
Example of Quantifying What You Can
  • We have escalating problems with our current Business Intelligence system.
  • It will cost us $3,000,000 for a new system.
  • The present value of the quantifiable benefits of the new system are $2,000,000.
  • The NPV of the new system is ($1,000,000).
  • There are unquantified benefits in making the investment:
    • Raise morale of managers and IT staff.
    • Signal commitment to knowledge management.
    • Better impression for visitors (customers and analysts).
  • Consider the $1,000,000 negative NPV as the cost of the unquantified benefits.
strategy and finance

Strategy and Finance

Shareholder Value

Control Systems

total shareholder returns tsr
Total Shareholder Returns (TSR)
  • Share price at the end of 2006 is $100
  • Share price at the end of 2007 is $120
  • Dividend payment in 2007 is $10

Share Price Appreciation of $20/$100 = 20%

Dividend Yield of $10/$100 = 10%

Total Shareholder Returns = 20% + 10% = 30%

scenario assumptions
Scenario Assumptions
  • You buy one share of a company for $100
  • The company invests $100 in a project
  • You are the only shareholder and your $100 is the only source of capital
  • You, and the company, and the market have a discount rate of 20%
slide52

Positive NPV Scenario (Bigger Pot)

Project

$140

Pot O' Money

  • What was the value of the share before the investment in the project?
  • What is the value of the share after the investment in the project?
  • If the company pays a $20 dividend, how many nominal dollars will be left in the Pot at the end of Year One?

Equity

slide53

Zero NPV Scenario (Same Size Pot)

Project

$120

Pot O' Money

  • What was the value of the share before the investment in the project?
  • What is the value of the share after the investment in the project?
  • If the company pays a $20 dividend, how many nominal dollars will be left in the Pot at the end of Year One?

Equity

slide54

Negative NPV Scenario (Smaller Pot)

Project

$100

Pot O' Money

  • What was the value of the share before the investment in the project?
  • What is the value of the share after the investment in the project?
  • If the company pays a $20 dividend, how many nominal dollars will be left in the Pot at the end of Year One?

Equity

warren buffett and intrinsic value
Warren Buffett and Intrinsic Value

Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses.

Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.

jays buy skydome for 25 million
Jays Buy SkyDome for $25 Million

SkyDome, the stadium that cost $578 million to build, was sold to Rogers Communications Corp. for the bargain price of $25 million. SkyDome has cost taxpayers $360 million and sits on land leased from the City of Toronto and the federal government.

Blue Jays president Paul Godfrey says the deal's valuation was based on the cash SkyDome can generate, not on the amount it cost to build.

the logic of shareholder value
The Logic of Shareholder Value
  • Shareholders want the Pot O' Money to grow
  • Projects with positive NPV make the Pot bigger
  • The value of a company is the sum of the NPVs of all the company's projects
  • Managers must invest in projects with positive expected NPV and ensure that the projects are successful
  • Where does positive NPV come from?
slide59

The link between Finance and Strategy

How do you make the Pot grow bigger?

Where does positive NPV come from?What is the NPV of any investment in a perfectly competitive environment?

sustainable competitive advantage
Sustainable Competitive Advantage

Brand name

Technology

People and How

People Work Together

Product

Capital

Process

Legal and political

the ultimate source of value
The Ultimate Source of Value

Shareholder Value

comes from competitive advantage

and all sustainable competitive advantage

comes from

people

and how people work together

an investment checklist wwwd what would warren do
An Investment Checklist - WWWD?What Would Warren Do?
  • Is it a real business?

What are the prospects of future cash flows?

  • What is the competitive advantage?

Can anyone do it?

  • Who are the people and how do they work together?

Is there a sustainable competitive advantage?

criteria of control coco
Criteria of Control (CoCo)

Purpose

Monitoring

and Learning

Commitment

Action

Capability

decisions are made in context
Decisions Are Made in Context
  • Individuals make decisions
    • Personality issues
    • Rewards
  • Decisions involve organizations
    • Systems (information and models)
    • Other people
  • What is top management saying?
  • How is performance measured?
  • What is rewarded?
  • What resources do people need?
  • Does the company have tools to monitor and learn?

Purpose

Monitoring

and Learning

Commitment

Action

Capability

pc spreadsheets celebrate 25 years
PC Spreadsheets Celebrate 25 Years
  • VisiCalc late 1970s
  • IBM PC 1981
  • PC spreadsheet in November 1982 - killer app
  • Significant impact of spreadsheets by 1988
    • Widespread use of spreadsheets by managers
    • Changing role of finance function
    • New tools for planning, decision-making, budgeting, etc.
  • Finance uses spreadsheets for
    • Monitoring
    • Decision-making
    • Information management
    • Porting and formatting data
need for monitoring systems
Need for Monitoring Systems
  • Definitions
    • Monitoring - Are we on track?
    • Learning - Are we on the right track?
  • Monitoring frees finance and operating managers to focus on learning (strategic issues)
  • Monitoring requires relevant measures - timely and actionable
spreadsheets are failing
Spreadsheets are Failing
  • Unintended use - kludgey link between systems
  • Internal control problem - undocumented spreadsheets prone to error and fraud (SOX)
  • Efficiency and effectiveness problem - accessing, processing and presenting vast amounts of data

Performance Management (PM) systems address these issues.

traditional approach to pm
Traditional Approach to PM

Budgeting/PlanningApplications

ConsolidationsApplications

ScorecardApplications

ForecastingApplications

Patchwork of Applications

Spreadsheet Overload

Data is out of control

Multiple Installations, Integration Points, Upgrades, Training Programs and Interfaces

Massive ManualReconciliation

  • Results:
  • High user adoption
  • IT is uninvolved
  • Finance is dissatisfied
  • Low confidence in results
  • Results:
  • Low user adoption
  • IT is frustrated
  • Finance is using multiple user interfaces
  • High cost of ownership
a better approach to pm
A Better Approach to PM

Single Unified Solution

Plug into OLAP and Relational Databases at the Same Time

Plug into Existing Cubes and/or Tables

No Data Model Constraints

One Simple User Interface

Support All Leading Databases

Support Any Data Model

One Install

One Upgrade Path

Unified Licensing Model

Access Over the Web

Central Database

Consolidations/Budgeting/Planning

Forecasting/Dashboards/Reporting

  • Results:
  • High user adoption
  • IT is satisfied
  • Finance is delighted
  • Low cost of ownership
selling to finance
Selling to Finance
  • Identify problems and present solutions, not technologies (use language of Finance not IT)
  • Present opportunities in strategic not technological context (use language of Finance not IT)
four step change process required for any finance initiative
Four Step Change ProcessRequired for any Finance Initiative
  • People affected by change must understand the "theory" and the financial rationale of the change
  • People affected by change must be involved in the implementation of change
  • People affected by change must be trained to exploit the change
  • People affected by change must be rewarded for responding to the change
summary
Summary
  • CFOs live at the intersection of strategy and finance and have their own language and tools.
  • Use the Q-T to understand financial accounting.
  • Ask questions about IT allocations and think about cost drivers from the customer perspective.
  • Use CVP to analyze the impact of an investment on profit and DCF on shareholder value.
  • Understand a company’s control system to understand how decisions are made.
  • Spreadsheets.
  • This is a Pilot Program – we appreciate your feedback.