💥 When Control Isn’t An Option

Shall we talk about fraud?

A word

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Working Capital

Out of Control

It was worse than I thought.

I had been in the seat for only a couple of weeks, and the balance sheet was a mess.

The financial controls were weak. The team was even worse.

I had been warned by the board and the outgoing CFO that there was still ‘a bit of work to do’. That had been an understatement. Only the audit partner had been straight with me.

She’d told me how broken the finance function was.

The business had developed all sorts of unusual management accounting practices. The finance team focused on producing P&Ls that would ‘make sense’ to the operational team. The balance sheet was an afterthought. And this was a complicated, decentralized balance sheet across multiple ERPs. This was headed for accounting armageddon.

It would take time to make the changes to the leadership, culture, and team. In the meantime, it was going to take some manual grunt work to avoid a disaster in the books.

I started to show up to monthly balance sheet reviews. Even at levels well below my pay grade. This was no time to be precious.

I needed to send a message to the whole finance team. Balance sheet hygiene was the first priority. We did things properly now.

It took about twelve months to get the balance sheet cleaned up.

But slowly the pendulum shifted. It took a bunch of personnel changes, and much more of my own time than I initially expected.

Financial controls were improving; the first foundation of finance.

There was just one problem.

The operational teams had gotten so used to reporting in the old way, that they no longer recognized their P&Ls. They were forced to deal with inventory write-offs in the correct period. Bad debt reserves were reassessed monthly. No more spreading costs inappropriately. Wacky intercompany pricing policies had been straightened out.

And this was a real issue. They used weekly and monthly Income Statements to drive decision-making, and they no longer felt connected to it.

We had improved financial control but at the expense of operational control.

We understood the balance sheet now, but no one understood the Income Statement.

This business was not yet ready to understand both at the same time.

That would have to wait for another day.

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Deep Dive

This is the final part of our series on financial controls.

When Control Isn’t An Option

Most businesses are closer to disaster than you think.

The basics you assume everyone has covered? Well, not everyone does.

Just look at the Lyft this week.

Their earnings release guided that EBITDA margins would increase by 500 basis points.

2023 margins were 1.6%, so that is a hell of a 'lift'. 1.6% + 500bps = 6.6%. Equivalent to an unexpected increase of over $600m in EBITDA. Well beyond what the market was expecting.

The stock took off like a rocket.

One problem. They got their bips in a flip. They meant 50, not 500. i.e. the 6.6% margin guidance for 2024, was, in fact, 2.1%.

Still a respectable 30-40% increase in EBITDA guidance. But nothing like what the market had believed (if only for a minute).

That took the stock on a whirlwind journey for a couple of hours, fueled by an error in the market guidance.

All because of a rogue zero.

If a public company with $5bn market cap can make a mistake like that, anything can happen.

Not something I was planning on talking about this week, but it does lead us nicely back to control.

Specifically, what do you do when you don’t have control?

You can’t press pause. You have to repair the plane while flying it.

I have built my career on turnarounds. Businesses with weak performance, oftentimes have weaknesses in operational and financial controls. Not always, but often.

Even when the books are a mess, and the team is weak, you still have to publish your monthly numbers. And sign the accounts at the end of the quarter.

This is an uncomfortable place to be. You don’t know what you don’t know.

In business, bad news compounds. If there are control issues, there are reporting issues. If there are reporting issues, you are making bad decisions. If you are making bad decisions, the business will suffer. If the business is hurting, your best people will leave.

The snowball effect, but instead of snow, it's made of something brown and smelly.

Stopping the sh*tball while it's rolling is really tough.

This is where a first principles understanding of how finance functions work is invaluable. We will talk in a future series about how you build that understanding.

For now, we will focus on what you do when you are the CFO of a business when you can’t trust the books.

Balance Sheet First

You can learn a lot about how a business operates from an interrogation of the balance sheet.

I see too many CFOs who don't understand how their balance sheet works. It's the “job” of the controller, bookkeeper, or whoever. That is right. But it’s your job to make sure they are doing their job. And how do you know they are doing their job if you don't understand how the balance sheet comes together?

If the balance sheet is wrong, it's not just your job on the line. It's your reputation. Your career. So know that whoever you entrust with your balance sheet, your career is in their hands.

Even if I had the best VP of Finance or controller in the world, I would still insist on a decent understanding of how the balance sheet comes together:

  • Who owns which part?

  • What are the review processes?

  • How are issues escalated?

  • How are they resolved?

  • How do you ensure nothing gets missed?

  • What are the completeness checks?

If you are sitting in a CFO seat and can't answer those questions, you are not doing your job.

I’d bet that Lyft’s rogue zero got missed because everyone else thought someone else was checking it.

When Lewis Hamilton steps in his car, he has a team to make sure his brakes work. Are you telling me he doesn't give them a quick squeeze himself, just to make sure, before the start of a race? It’s his life on the line, after all.

Here are the three tools I use to make sure my balance sheet is in safe hands:

  • Balance Sheet Accountability. Make sure you can put the name of a responsible controller against every balance sheet code in the business for every operating location.

  • Controller Certifications. Get your controllers to sign a certification for accuracy, completeness, and disclosure of their assigned balance sheet areas.

  • Risks & Opportunities. Keep a master list of all balance sheet ‘risks and opportunities’ for the year you are in. Landing this on a dime by the time you close the quarter/year, is an art form.

And above all else foster a culture of transparency, openness, and integrity. If you have people in your team who can’t live up to this, get rid of them. And do it in the town square if that’s what it takes to send the message. 

When reporting is wrong, there can be three motivations:

1. Innocent. It's wrong. But it's wrong with hindsight. They miscalculated, despite their best efforts

2. Negligence. They got it wrong. They weren't trying to get it wrong. But their capability or attitudes weren't good enough to stop it being wrong. This could be a factual error or just poor/conflicted judgment.

3. Fraudulent. Willful misstatement. They knew it was wrong, but did it anyway to make their results look better.

1 is bad luck

2 is a capability or attitude issue (or both)

3 is an integrity issue

You may choose to have patience with a capability issue. Especially if it’s hard to recruit a replacement - often it is for businesses with broken controls. You should not have patience for reporting issues caused by poor attitude.

And in the case of even the smallest sign of results manipulation you need to be brutal, and make examples. You won’t sleep well as long as there is someone in your finance team whose integrity is questionable.

Mindset Shift

Ensuring that controls are in good working order is no small task. You have to get your hands dirty. And you may have to re-plumb the finance function. 

Here are the five mindset shifts for a CFO leading a business where the financial controls are a mess:

1. Assume Nothing Works

This is the big one. There is never one rat in the kitchen. Approach everything with the mindset that it is wrong, until you KNOW it is right. You should be asking questions like:

  • What is the data source behind this?

  • Can you show me how this ties through?

  • How do you know this is right?

Auditors call it professional skepticism. I’m forever grateful for it being trained in me in the first couple of years of my career.

2. Everyone Steps Down a Level

It's no good sitting in your office barking orders at people while Rome is burning. Most people don't come to work to do a bad job. Get your hands dirty and show them the way.

It is your experience at the level below that will be helpful. Same for your team. It also sends a message; we’ll fix this together.

3. Build 10-Year Fixes

You inherited this mess. It’s not on you. But now it’s yours to fix. If it falls apart again in 12 months, then it will be on you. You need to build fixes while you work.

People, Processes, Systems. In that order. 

Hire people who will build processes. And more importantly, don't care about 'the way things have always been done around here.’

4. Zoom In and Out

You need to make sure you don’t lose oversight of your whole garden while your nose is in the weeds. Having the skill to zoom in and back out again is vital here.

Having a clear map of all the issues and the likely impacts/worst cases will help you prioritize where you should spend your time.

Plenty of CFOs can operate ‘strategically’. Plenty more are ‘good in the detail’. Some can do both.

But only a small minority can flip between strategy and detail at will and be in the right place at the right time.

5. Manage Upward & Outward

This will be a frustrating time for your stakeholders. Lots of one-time adjustments while you clear up. Shifting sands in the P&L as you clean up accounting practices. Low confidence in the output of the finance function.

This is where you really earn your money as the CFO. You need to give the team air cover and time to solve the issues.

There will be questions from your CEO and board about whether you can fix it. Maybe to your face, definitely behind your back. They aren’t doing their job if they don’t ask that question.

Make sure you have a simple way of explaining the issues, what you are doing about it, and how long it will take. Be transparent, and show measurable progress.

And make sure you don’t surprise them in the numbers. Even where a surprise is inevitable (known unknowns). At least make sure they know it is coming with a time and value range. Do this one thing well, and it will have a huge impact on their confidence in you.

Even if you don’t find yourself fixing a complete sh*tbag you can use these techniques to solve one-off localized integrity issues in your financials.

Misappropriation of Assets

I want to finish this series by sharing a thought on theft. Businesses with weak controls attract thieves. Both internally and externally.

This needs a series in its own right (I have some stories to tell here). But there is one point that is too time-sensitive to wait.

Last week, an unnamed company lost $25m after an authorized official transferred funds following a call with a deep fake replica of the CFO.

I also recently heard (from a Big 4 partner) of an example where a voice call led to a similar fraud (multi-million dollars). They used the earnings call to scrape the Chairman’s voice and train an AI.

AI is going to take the marginal cost of attempting sophisticated impersonation fraud to zero.

If that doesn’t scare you, I don’t know what will.

If there is someone in my audience who is an expert here (Big 4 forensics partner or similar), I would love to talk to you or interview you for this newsletter.

In the meantime, be careful.

This is the end of our series on financial controls. A special edition next week, followed by a series on the CFO skill stack in March. This is a highly requested topic, can’t wait to share it with you.

Bottom Line
Bottom Line SCFO
  1. There is no substitute for a tick and bash of the balance sheet. This is where the gremlins hide.

  2. It takes time to change a control environment. It’s cultural. Make sure you manage your stakeholders through the change.

  3. Fraud is about to become a whole lot more sophisticated thanks to AI. Be on your toes.

Office Hours


Robert from New York City asked:

How do I, as a CFO, balance the tension between serving as the "guardian of fact" for the Board and serving a CEO who is advocating for reporting more robust financial results (via adjustments to reserves, let's say), and/or a more robust forward plan (via optimistic assumptions)? Does it make a difference whether a CFO is on the Board or not?


Ahhh Robert. This is a tale as old as time. The short answer is that this is a game of fine judgments and great communication. Experience helps.

The longer answer is that you need to practice radical independence. That means forming an independent judgment, free from bias, of what you believe the truth is. Have that clear in your mind at all times, as the true North.

A healthy tension between optimism and realism is fine, especially in financial plans. You need the stretch to achieve the stretch. It’s a balance.

With forecasts, I like to think probabilistically. Is this forward plan a median case, a top quartile performance, a 70th percentile, etc.? The key then is how you communicate that. Make sure you present it in that way to your board and CEO. Also, if you feel your forecasts are too aggressive, present a downside case too.

With historical financial results, you need to be more careful. You have hard-wired obligations here. If your CEO is trying to pull you away from GAAP in a way you aren’t comfortable with, that is a problem.

I have always made clear to my CEOs that I make the decision on how things are accounted for. It’s not the CEO, it’s not us both, it’s me. I’m prepared to take input, but I make the decisions. And if they want a patsy CFO who does what they say, that is cool, but that person isn’t me. Making this clear up front is good practice.

Whilst your duties when a board director are more formal here, you should be following the correct principles whether a director or not.

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And Finally

Next week will be another special edition about the pathways to CFO.

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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.

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