When it comes to CFOs making an impact, they’re up against the clock from the get-go.
Relentless shareholder scrutiny, constantly shifting market conditions, and the never-ending specter of organizational changes all add pressure to show results quickly. Chief among them: return on invested capital (ROIC).
Why ROIC? Because, according to many, it’s the most important metric of financial value creation. In calculating it, perhaps the most significant driver for many businesses is capital allocation (Capex).
Fortunately, with the right tools, it’s also where the CFO’s team can quickly make its mark.
Still mired in manual processes, generic workflow systems, and disconnected data? Time is ticking.
Pretax ROIC is strongly correlated with valuation
In a nutshell, ROIC divides after-tax operating profit by invested capital, and paints a clear picture of how effectively a company is using that capital. Basically, the better return you can produce on your capital, the more investors will pay for your company.
That’s what McKinsey found in their study of S&P companies over the last few years, which showed a 75% correlation between pre-tax ROIC and enterprise value.
Now, you may be asking, If ROIC is so important, why isn’t it talked about as often as earnings per share (EPS) or price-to-earnings ratios?
One explanation may be that managers tend to spend much of their time focused on operations, where they have more expertise. As a result, those that make it to the executive ranks are often savvy operators who know the day-to-day workings of their business inside and out.
While Opex tends to be consistent month-to-month, Capex is more periodic. A railroad executive may have years of experience coordinating schedules, managing a workforce, and responding to delays. But a big roadbed repair project that happens once a decade may have only occurred once or twice in his career, and require someone with more experience to facilitate the project.
Also, Wall Street tends to focus on short-term metrics like EPS, while ROIC is an indicator of growth in the long run.
Moreover, though companies generally approve fewer large capital expenditures than smaller projects, their successful implementation is paramount to the long-term health of a business. For these large undertakings, there are a number of pitfalls that can derail even the most buttoned-up projects, including delays, cost overruns, and scope changes.
For companies with significant Capex budgets, that can translate to considerable financial impact. Which is why the depth, intricacies and interconnectedness of capital projects demands every advantage that automation, financial intelligence and other technologies can provide to aid how its reported and analyzed to maximize returns. That’s where Finario comes in, covering every stage of the capital planning lifecycle.
Creating a Complete Picture
Mergers and acquisitions can be great catalysts for growth. But they are also inherently risky,
as deals typically involve shouldering significant debt and meshing different cultures together. There’s also usually months or years of due diligence required ahead of time.
For those reasons, they are apt to undergo far more internal scrutiny … as well as vetting by the board of directors. Having a strong Capex track record, and solid handle on where the company stands with its cash commitments, can be key to getting the green light to do those deals.
Lastly, because the lifetime of longer-term capital projects can exceed that of people who have approved it, and organizational changes can be the norm, the importance of having the entire data set – from strategic rational to ROI models and risk assessments … approval history to post completion reviews and reports, can be critical to providing necessary insight and continuity to create a truly complete capital allocation picture. Once again, that is where Finario shines.
Ultimately, the most successful CFOs – those who embrace their role and the pressures that go with it – have a keen understanding that maximizing ROIC is an objective that can’t be ignored. Data, insights, and automation are essential to that objective and Finario helps them get there smoothly and efficiently.