This is CFO Secrets. The weekly newsletter that whispers sweet finance nothings into your ears every Saturday morning.

10 Minute Read Time

In Today’s Email:

• 📐 Measuring and Reporting Cashflow

• 👨‍👦 A Questionable Paternity Policy

• 🔥 Robert Sterling on Fire Again

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THE DEEP DIVE

Holding the Mirror Up: How to Measure and Report Cashflow Performance

This is the third week in an 8 week season covering how to build a culture of cashflow obsession in your business.

It’s fall of 2008.

Banks were imploding.

Like many corporates at that time, we had to move fast to stay liquid.

We had plenty of short term debt maturing over the next 12 months.

Would the credit be there to recycle our commercial paper?

We had to assume not.

This was a time to look inside the business for cash.

The corporate edict came. All divisions were set a short term cashflow challenge.

Delivery was not optional. The Group CFO himself briefed the entire finance team.

This was a business with over $100bn in sales. We weren't used to seeing the CFO address the whole finance team directly.

He was clear: this was life or death.

Whilst this was an exaggeration with hindsight, these were uncertain times.

We got on and built our plan.

I worked with the COO for my division to figure out how we’d reduce inventories by $250m. It would take six months, and we needed a fast start.

A month later, my team produced the first progress reports.

I was excited. How much of the 9 figure challenge had we landed?

We had a great operations team who loved a challenge.

But it wasn’t good news.

The answer was zero.

In fact, inventories had increased by $10m.

All this noise, and we'd delivered nothing?

I had to take the news to the COO. A strange man with a love for uncomfortable silences (he went on to be the CEO of a large public company).

The inventory was spread over hundreds of operating locations. So, these were hard yards.

The COO was quick to diagnose the problem:

It sounds obvious now, but this wasn't an uncommon problem.

Left to their own devices most businesses will not optimize cashflow on automatic.

Sure, it will become a pet topic every now and then. But you never know when you’ll need that cashflow muscle.

It’s not a light switch. Once it's gone, it takes time to re-establish.

It was a lesson. From now on, any finance team I led would make cashflow the lead finance performance measure.

Cashflow would always be a priority. Even when it wasn't.

KPI dashboards or balance scorecards don’t tend to incorporate cashflow well. Or weight it properly.

If you want cashflow to get a seat at the table, you as CFO will have to make it so.

Today's post covers how to do that.

Specifically we will discuss how to deliver Maintainable Free Cashflow (MFCF). The best sort of cashflow. If you need a recap on MFCF, read last week’s post.

McDonalds deliver $5-7bn of free cashflow a year. That's a lot of $2.49 hamburgers.

So many variables. So many people. So many points of failure.

Decentralized, yet coordinated.

But, how?

It starts with clear accountabilities.

Cashflow Accountability Grid (CAG)

To illustrate this, use a document called a Cashflow Accountability Grid (CAG).

A CAG should allocate the accountability for each part of cashflow (MFCF) to an individual:

Moving down the CAG vertically... there is a separate row for each component of MFCF.

And moving horizontally right. A column for each operating division, function, business unit, location, or geography. Whatever structure is relevant for your business.

In the example. The Divisional CFO for Division C is accountable for delivering the receivables performance for Division C.

Likewise, the maintenance capex spend in Division A is the accountability of the VP of Ops in Division A.

The specific names in the boxes, in this example, are not what is important.

What matters:

• One name in each box. But one name only.

• It must fit your particular organizational design. What would be right for McDonalds, would be different for Salesforce.

• Everyone is clear on their role

With this one tool, you share the the problem of cashflow delivery with the whole business. A problem shared, is a problem halved.

Depending on the depth and size of the organization, and it’s design, you may go one or more level deeper. Here is an example of how you might do that for Division A.

You can go as many levels deep as you need to. Whatever it needs to establish clarity.

McDonalds have over 40,000 quick service restaurants globally. If the payment terms for fries change from 55 days to 50 days, that could influence the cashflow performance of all 40,000 restaurants.

Is that something you hold individual store managers accountable for?

Of course not.

With accountabilities set, the next stage is much easier.

Setting the right targets, and performance metrics and reporting.

Much like the FP&A cycle we can break that down into different time frames:

There is some overlap here with the recent series on Financial Planning & Analysis. (First issue of that series here)

So I won’t repeat the principles of good FP&A. I’ll assume you read the series.

But I will dive into a few areas under each key cycle interval.

Annual Cycle

It all starts here.

There are 3 key steps in the annual cycle for hardwiring MFCF into performance management:

1. Long Range Plan

2. Budget Setting

3. Bonus Schemes

If you need a recap on the broader principles for any of these, check out that FP&A series I mentioned.

Long Range Plan

It all starts with the 3-5 year financial plan.

The best metric for cashflow here is MFCF % Return on Net Assets.

For example if your current MFCF is $100, and net assets at $1000. You have a 10% MFCF return on net assets.

Your 5 year goal could be to increase that by 100 bps per year to 15% in year 5. This makes sure of two things:

1. You target an increasing efficiency of MFCF return on existing net assets

2. That any capital allocations (increases to net assets) are also subject to an increasing return expectation.

This can of course get broken down by division or operating unit as far as you want to go.

Budget

Once you have a 5 year trajectory for MFCF you can convert that in a $ value for the financial year ahead.

Through the budget process this should get broken down into $ targets for each cell in the CAG. You can call this a Cashflow Target Grid (CTG)

Let’s take an example:

The total Group target is $110, and the CTG shows how you get there by cash component.

The shape could be very different by business. In this example, Division C and Division A are cash cows. Division E could either be a turnaround, or a high growth division.

Getting this shape right will feel difficult. Especially if your business isn’t used to putting stretch targets into cashflow delivery. But with each cycle, it will get clearer what is, and is not, a reasonable place to push.

And behind each cell you will have a month by month target that adds back to the annual total. Just like building any budget.

You now have the atomic unit for performance measurement.

Bonus

You should then build these targets into annual objectives, and the bonus scheme. If you want people to care about cashflow, you have to link their pay to it.

Specifically, you want them

a) directly incentivized against the components they control (see the CAG).

b) having some stake in the success of the bigger goal. I.e. MFCF for their division or Group.

This is why the CAG is so important. With clear accountabilities, and agreed targets, it becomes a natural extension to link it to bonuses.

MFCF % Return on Net Assets makes a wonderful target for a Long Term Incentive Plan (LTIP) too…

Quarterly

The quarterly routine focuses on energizing the whole business around cashflow.

The goal here is engagement, rather than performance management.

The ideal format is a quarterly all-hands or townhall meeting.

Key things to communicate:

• Did we miss or deliver previous quarters MFCF $ target? Why?

• Are we ahead or behind the YTD target MFCF $ target? Why?

• What exactly do you need the business to do differently to improve performance?

• Launch the next quarter’s cash improvement initiatives. the ‘cash surge.’

Cashflow Surge

A cashflow surge is a simple quarterly process that brings intensity to delivering short term cashflow goals.

If you want to take your inventory from 30 days on hand to 20 days on hand. Or working cap % from 9% to 7% of sales. That will not happen overnight. It will need grinding out.

$1 at a time.

The Cashflow Surge is where you make that real, current, and intense.

Pure focus on the 3 or 5 things that will move the cashflow conversion needle in the next 13 weeks. And I’m talking about real lasting change to the shape of working capital. Not quick hits to help reporting (that is fools gold). More on where you might find those upsides later in the series.

Each action should have a name, value and date against it. Public accountability is potent.

No-one wants to see a red blob on the screen against their name in the next quarterly town hall.

Monthly

This is where the rubber hits the road. Performance management.

The routine of managing performance of a month’s actual vs budget is the golden thread of business performance. I’ve said an awful lot on this in the past. If you want a recap, read this.

This is best done, using a Cashflow Performance Grid (CPG). This is simply a variance statement of performance vs the budget set in the CTG.

This example CPG tells an immediate story:

• Our cute little growth division E, is over delivering profit, but with reckless disregard for cashflow. Heads need knocking.

• Division B & C have a profitability issue, but are using the rest of the cashflow levers to try and offset that. Core trading needs fixing

• Division A have something going on in inventory. Investigate.

• Higher interest rates have blown out our interest line. Not much we can do about this in short term. We are going to have to overdeliver elsewhere.

I don’t care how well your business is performing, you will have something that is down vs budget.

I call this ‘Hitting the Reds’.

Even if you are ahead of budget overall. Keep a relentless focus on any component that is not performing. ‘Hit the reds’.

Remember the example at the start of the post. It is hard to re-wire a business, or even a part of a business, to care about cashflow once it’s lost that muscle.

Your job as CFO is to make sure the business keeps getting its reps in. Whether the business thinks it needs it or not.

You need to keep every part of the business sharp on cashflow all of the time.

And besides … if you are staring at black variances 90% of the time, then it doesn’t mean you are awesome.

It means your budget are too soft.

Push harder soldier.

Weekly & Daily.

I won’t cover weekly and daily cashflow management detail here. At this end of the cycle, this is less about reporting and metrics, and more about process. And we are going to cover this in detail later in the series.

Specifically in week 6 when we get into how you improve working capital performance.

Keep Metrics Simple

A quick note on metrics. You will have noticed that I haven’t recommend many complicated ratios or metrics here.

In fact, most are just expressed in $m.

There is a good reason for that.

There is a whole world of complex, clever, and technically correct cashflow ratios. We finance people love getting lost in that sort of thing. And that’s ok amongst the right people.

But remember what I said earlier. That MFCF gets delivered in the business.

Decentralized.

By ordinary people. With proper jobs.

Not poncing around in spreadsheets all day like you and me.

Keeping metrics simple is the key to connecting with the wider business. Most people won’t understand cash conversion cycle. Not properly.

But they will understand $. Everyone understands $ notes.

“Hey Bobby. You forgot to rotate the widget inventory and it increased our DIO by 2 days last month”

Bobby doesn’t care.

“Hey Bobby. You forgot to rotate the widget inventory and we had to throw it out. It cost us $50,000.”

Bobby cares.

And if Bobby and all his buddies care enough, we will hit our cashflow targets.

Homework

1. Build a Cash Accountability Grid for your business

   1. Identify the ‘atomic units’ for cash delivery in your business

   2. Put names against each one

2. Calculate your current MFCF return on net assets

   1. What would be a stretching 5 year goal?

   2. What is a reasonable $ MFCF target for next financial year

3. Cashflow Surge

   1. Plan your first cashflow surge

4. Adapt FP&A Cycle. Timing will depend on where you are in current annual cycle

   1. Adapt next Long Range Plan process to optimize for MFCF return on net assets

   2. Build MFCF delivery into monthly performance management cycle

You might have noticed I didn’t talk about cashflow forecasting. That’s not because it isn’t important. It’s critical.

So much so, that the next two issues of this season will be dedicated to the topic. There’ll be no post next week, but we are back on November 11th with the first of those two posts on cashflow forecasting.

THIS WEEK ON SOCIAL MEDIA

I’ve been quiet on social media myself recently. CFO life has got in the way. Budget season; what can I say…

But here’s what’s been keeping me entertained:

This cracked me up.

Robert is my number 1 favorite follow on X. He’s a triple threat: smart, genuine, and he makes me laugh every day.

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FEEDBACK CORNER

This review of the last post made me happy:

I’m impressed by any 24 year old who is learning and listening from those that have walked the same path. I didn’t have that maturity at 24.

I want this newsletter to be the next best thing to hands-on CFO experience. Helping you feel what the CFO job is like before you actually get to take the chair.

AND FINALLY…

That’s all for this week. I will be taking a break next week, but back with a bang on November 11th. A two parter on cashflow forecasting; one of my favorite topics.

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Stay Crispy,

The Secret CFO

Disclaimer: I am not your accountant, tax advisor, lawyer, CFO, director or friend. Well, maybe I’m your friend, but I am not any of those other things. Everything I publish represents my opinions only, not advice. Running the finances for a company is serious business, and you should take the proper advice you need]p