The Value and Characteristics of a Competent CFO in Middle Market Companies

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Having worked with hundreds of middle market companies over the past 20 years, FortéOne has learned that a competent Chief Financial Officer (CFO) who regularly adds meaningful value in his/her firm is a rare commodity.  In many companies, there are financial professionals with the title of CFO or VP Finance, but the function they are performing is that of a Controller. Further, because many business owners have never experienced the value that comes from working with a competent CFO, they do not comprehend the enormity of this hole in their leadership team. Stated simply, a great CFO is worth many times their compensation in value to a middle market company every year.

Why is a Competent CFO So Essential?

What makes a CFO so essential? Why are great ones in such short supply in middle market companies? First, let’s discuss value. A Controller is concerned with ensuring that internal financial processes are managed (i.e., books closed, A/R and A/P managed, and accurate financial statements published).  These financial accounting functions are, by their nature, historical.

Everyone knows that you can not pilot a car by looking in the rear-view mirror, nor can you lead a company with only historical data. The value-adding CFO is key to the future success of the company. A competent CFO amasses information, data, and trends from all areas of the organization to understand current performance, predict future profitability, and ensure management throughout the company understands the “why” for all key variances versus the budget (or plan) and from actuals.  In fact, the CFO takes the leading role in not only developing the annual and 3-5 year forecast / plan but also in the identification across all departments / functions of hundreds of line items that add up to where and whether or not each customer, each product, each manufacturing line, each geography served, and the overall company are making money.

Besides having the necessary experience and accounting credentials, there are other qualities required for a CFO to be truly effective. They need to be curious, relentless, and diplomatically courageous. Curious about understanding every aspect of the operation and relentless about collecting data and creating actionable information. Courageous in highlighting department financial variances, company issues, and (where appropriate) organizational and system shortfalls—all in a way that does not alienate internal and external relationships. High performing CFOs do not sit in their offices all day in front of computer screens. Because they need to understand the intricacies of business operations, they spend time on the floor with managers, supervisors, and line workers. They interact with customers, suppliers, and a myriad of external resources such as company tax firms, lawyers, insurance brokers, and more. High performing CFOs understand that through knowing the company’s business intimately, they can develop the information, as well as the reporting and control systems, needed to ensure leadership is making informed decisions and driving results. And finally, they must develop great working relationships with the leadership team and learn the working styles of everyone at that level. Those close partnerships are essential for ensuring the appropriate information is available to enable “informed decisions” from the leadership team.

Why are Value-Adding Competent CFOs Rare in Middle Market Companies?

There are three reasons why competent CFOs are a rare commodity in mid-size companies.

  • First, they require a foundation of accounting knowledge supplemented with hands-on operational business experience. Many financial people simply do not “get out on the floor” and learn the operational details of the business.
  • Second, there are few good mentors for CFOs in middle market companies who teach how to become “effective change agents” that quantify and identify potential solutions as well as opportunities for the wide range of problems generally encountered in virtually all organizations. This is why many of the better mid-market CFOs have spent time working in well-regarded accounting firms or in the financial departments of larger companies (where they have good mentors and a wide variety of change leadership experiences) before moving to the middle market.
  • Third, value-adding, competent CFOs require an understanding of data and the systems required to collect, analyze, and present key information. In many middle market companies, the financial, ERP and data reporting systems are poor or absent. Growing up in this environment puts financial people at a major career disadvantage since they never experience more optimal methods for assisting the company and how they should be implemented. To build the necessary skills, a competent CFO needs to supplement their financial credentials with change leadership, operational understanding, and systems competence. This is why many CFOs who have grown up exclusively in middle market companies struggle to adapt and often fail their owners as the company grows and/or the job becomes more complex due to evolving industry, technology, customer sophistication, and marketplace competition.

Bad Data = Bad Decisions = Bad Outcomes

Absent a competent CFO and the information they provide, the leaders and department heads in middle market companies make bad decisions. And these decisions span the gamut of customer, product, other market-facing and operational areas. FortéOne knows this because we have seen the disastrous financial fallout from poor decisions in companies across many industries. When asked to assess a company, we are often unable to rely on the data—because it is not available, or it is incomplete or inaccurate, or often all three. For this reason, we include CFOs (or CFO Mentors) on most FortéOne engagement teams to develop, as part of our assessment, the information that a competent CFO would develop in the normal course of business.

In most middle market companies, there are a number of financially related issues we encounter.  Several of these are listed below, along with the resulting poor business decisions / bad outcomes.

  • Financial Books that are not closed on a timely schedule, with material correcting entries made weeks laterCompany Owners and Leaders have no timely warning of profit and revenue impacts, or budget variances, nor are they able to take corrective actions in a timely manner. Often, the “warning signals” come months later, or not at all, and the damage has been done.Leaders are unable to report timely results to their investors or lenders, and this reduces their credibility and creditworthiness.
  • No sense of the True Cost to Serve customers, or the Cost of providing products & servicesLeadership without accurate and timely data adds new customers, new products/services and expands into new geographies with small or in many cases negative contributions to profits. These situations additionally exact a significant “wasted” opportunity cost for the company  when the resources could have been applied to a more successful growth opportunity.Absent true Cost to Serve calculations, it is impossible to accurately price new and existing products.   FortéOne has worked with clients who underestimated their true costs by as much as 27% and many were pricing their new products to lose money.
  • No clear understanding of where profit is made, or of 80/20 concepts and the need for continual SKU rationalizationIn these companies, all clients and products are considered equally important, including those that are using huge amounts of resources and losing money! Without accurate and timely profitability and performance data from the CFO, company leaders unwittingly continue to focus resources on bad decisions regarding capital investments, customers, and products.In many companies, we find that the bottom 50% of customers are responsible for less than 4% of revenue. These situations (which unfortunately are common in the middle market) are a huge drain on profits. These leaders have no idea that they are wasting company focus and invaluable resources.
  • No formal pricing process and no rebate / allowance analyses and trackingThese leaders do not understand the power of accurate, market-based pricing. They are unable to maximize their value in competitive bid situations, and they are not equipped to respond to competitive pricing threats.In many cases in the middle market, company leaders are “afraid” to raise prices for fear of losing their customers. Eventually, costs climb and profits drop. Sometimes entire companies burn through cash and wind up in a dangerous financial condition. In every case where FortéOne has worked with companies in these situations, we have successfully raised prices across customers with minimal loss of revenue and material gains in profit.
  • No formal criteria or stage gates for new customers or new productsEven when these leaders understand their Cost to Serve, they fail to leverage that information with customer and product selection. Without this discipline, poor decisions continue to be made with marketplace targeting, segmentation, and trend-right new product introductions.
  • No dashboard of key financial and operating metrics and leading indicators, or if these are tracked, no explanation of variances versus Budget and versus Last Year Actuals. Most importantly, insufficient data is provided, and little-to-no discussion occurs monthly as to why the profit-diluting variances occurred and what is needed to correct themThese leaders are not able to institute a Culture of Performance that sets goals, reports on progress against these goals, and monitors ongoing actions to achieve them. Absent clear numeric goals and a tracking mechanism for their staff, the company is essentially “rudderless” and becomes more and more inefficient in many areas.These leaders make poor decisions because they are not appropriately tracking (if at all) the important historic as well as forward looking indicators that would allow them to make “informed decisions” to grow the company successfully.
  • For manufacturers, a poor understanding of cost of materials, inventory dynamics (including optimal min/max levels, order lead timing, etc.), obsolescence tracking and waste minimization, and the myriad of other factors and actions needed to minimize working capitalThese leaders often are unable to control their working capital and make poor decisions with client contracts and inventory requirements because they do not understand the working capital “costs” they are incurring.
  • No formal RFPs for key products/materials or capital expendituresSimply stated, these leaders are choosing to pay too much for materials and their equipment, and once realized, these savings would flow directly to the bottom line.
  • Little or no appreciation for the impact that cost reductions (vs. sales increases) have on the bottom lineIn these companies, leadership does not recognize that a 2% decrease in costs may have a larger profit impact than a 10% increase in sales. They often focus management attention on sales growth and ignore other actions that could materially enhance the bottom line.

 

When middle market business leaders add an experienced value-adding CFO (or CFO Mentor) to their staff and work with them for a few months, the eye-opening way they then lead their business is forever changed. A competent CFO will correct the deficiencies listed above by building the information, process, and systems required for leadership to make much better, more informed decisions and drive results. This is because good leadership teams make data-driven decisions, and the competent value-adding CFO ensures that relevant, accurate information about the business is collected and presented in a format that can be acted upon. Make no mistake, a competent CFO in the middle market is a rare find but pays back many-fold in terms of increased profitability. They are well-worth the time and effort to attract, hire, and integrate into your leadership team.

 

Author: Mark Rittmanic