This is CFO Secrets. The weekly newsletter that would never let a CFO be pushed around by Kendall Roy.

10 Minute Read Time

In Today’s Email:

• ♟️ How to make strategic finance decisions

• 👴🏻 The Oracle of Omaha

• 😈 Is Greg a baddie?

Today is a long one … so grab a mug of coffee.

THE DEEP DIVE

Long Term Plan: How to Make Killer Capital Allocation Decisions

This is Week 1 of a 6 week series on FP&A.

“Forget your title. Your job now is to ration company resources. That’s it.”

I’d been promoted into my first BU CFO role. This was the pep talk from the Group CFO.

I figured he was over-simplifying it. But still, I played along.

He went on …

“It’s easy enough though. You make all the big resource decisions in the Long Term Planning process. That’s when you ask the hard questions. And make sure you get clear answers. Everything after that is execution.”

I nodded along. He had a point.

Years on I realize how profound this was.

I reflect back on over a decade since, and all the annual financial cycles I’ve been through.

Some have gone well.

Some have been a car crash.

The ones that were bad, were bad because we didn’t face into the tough choices soon enough.

Great businesses embrace trade-off decisions head on.

Some examples:

• We can buy Business A, but it means delaying execution of improvements in our core business.

• We can invest behind the capex plans of Business B or C, but not both.

• We can grow sales by 10%+ but only if we sacrifice 20bps of margin per year

• If we sell this part of the Business we can focus our management on the core business.

• We can commit to reducing Scope 1 & 2 emissions, but it will cost $$$.

• We can roll out Oracle but we need to delay all other corporate projects for 3 years due to resource drain.

By not facing into trade-offs like these, the lack of clarity flows into the budget.

And then ultimately compromises execution of an already flawed plan.

The consequence?

Teams are unclear on priorities. They divide company resources over too many activities. That’s a recipe for getting nothing done.

Great strategic planning is about making a small number of bold commitments.

The Long Term Plan is where you decide on those commitments.

As my former boss said; rationing company resources.

And not only financial resources.

Human, and technological resources too.

What is a Long Term Plan (LTP)?

Also known as: Strategic Plan, X Year Plan, Economic Plan, Long Range Plan.

It is the process for setting a high level multi year financial plan for the business.

It’s like a budget, but covering more than 1 year and at a much higher level.

Think of it like a strategy, but written in numbers rather than words.

Strategic finance decisions.

But how can you be accurate to a five or ten year forecast?

You can’t.

The purpose of the LTP is not to be accurate.

It is to provide a framework for making better decisions about the financial future of the business.

The LTP doesn’t need to involve a very large number of people, in the way a budget can. But it will be central for a small number of senior people.

There are 5 steps in setting the long term plan

1. Set the guardrails

2. Compile inputs

3. Iterate inputs and align stakeholders

4. Run scenarios

5. Make decisions & communicate

Let’s take each in turn

Step 1 - Set the guardrails

Decisions you make here will effect the efficiency and the output quality of the rest of the process.

The purpose of step 1 is to ensure clear direction on what to expect for the rest of the process.

I’ve seen many LTP processes go wrong because a lack of up front alignment between CEO & CFO.

The first critical question: Does your business have a clear strategy?

Defining the documented strategy itself is out of scope for this series, but know this …

A good LTP process is downstream from a good strategy.

The less alignment there is on the strategy, the longer (and harder) the LTP process.

You will need to use the LTP as a forcing function to drive alignment where you don’t have it.

The second critical question: What are the questions you want to answer from the LTP process?

Here you get the CEO, CFO, VP of Finance / FP&A, and maybe a few others together.

Brainstorm. What are the key questions you want to answer about the long term financial future of the business?

Try and identify the trade-offs.

In words for now is fine. You’ll put numbers to it later.

You may also find it helpful to run some very crude top down napkin math on the business. This will help identify these trade-offs, using your best guesses for assumptions.

The third critical question: How do you put parameters around the process to answer the questions above?

You need to do this on four dimensions:

1. Horizontal - Time Series

• Time horizon. 3-10 years of forward forecast is typical (with current year being Year 0). Number of years depends on the speed of the product cycle in your business.

• Time intervals. Almost always this is annual (occasionally calculated on quarters underneath)

• Year 0. Having a clarity around definition of the ‘base’.

  • Business often use the latest forecast of current year as the base (e.g. most recent 6+6)

  • If year 0 is particularly busy, you may find it helpful to work out the expected ‘exit rate’ of the business at year 0.

2. Vertical - Chart of Accounts & KPIs

• Summary Income Statement, Cash Flow & Balance Sheet. But at what level?

  • Keep this as simple as possible whilst getting what you need

• Capture the 8-10 key KPIs that drive your Income Statement

  • Some high level price, mix, volume indicators; $ per Unit, Units

  • Operational activity metrics

  • Cost efficiency measures; e.g. activity per labor hour

• Include other KPIs that could be relevant for consideration

  • More businesses are starting to include ESG KPIs as part of their LTP process.

  • Some are even using ESG to drive the LTP process

3. Organizational - Operating Units

• Determined by organizational design.

  • Regions, countries, business units, products, departments?

  • You should pick a small number of these. The key question is at what level is the Income Statement driven.

  • Keep it simple. Remember, this isn’t a budget.

  • This decision will affect design of the models and process

4. Building Blocks - How is it built?

• Picture this like a ‘bridge format’ walking from Year 0, to Year 1, to Year 2 and so on

  • What is the level you want to want understand those moves at? I.e. what are the building blocks?

• Make sure your building blocks distinguish Full Year Effects (FYE) from Part Year Effects (PYE)

  • FYE - the annualization impact of something that happened in the previous period

  • PYE - the part year impact of something that happens in this period

• Also distinguish between risks, investments & initiatives.

  • Risks - Things that will likely happen that will make the financials worse (i.e. inflation)

  • Initiatives - Things that must be done in the business to improve financials

  • Investments - Choices made to invest for future benefits (financial or non-financial)

• Key assumptions

  • Inflation rate (by major cost area)

  • Interest rates

  • FX rates

Step 2 - Compile Inputs

Now you have the guardrails for the LTP process you need to assemble the inputs. This means engaging a wider set of stakeholders. Divisional presidents, VPs, Functional heads, etc.

A good LTP process will only penetrate a layer or two down into the organization. Remember, this is not a budget!

You need to ensure that process you defined in stage 1 doesn’t get diluted here.

To ensure you keep that clarity, do 2 things:

a) Write a simple process document outlining the above, and build into a timeline. Some things to think about:

• Timeline (6-10 weeks)

• Roles & Responsbilities (Have a business lead and finance partner for each area)

• What are the review levels? Who has what decision rights?

• What output is expected. How is it presented back?

• What is the project management?

  • Kick off meeting

  • Weekly check in for project team

• Any indication on expected targets / outcomes based on the strategy or napkin math.

  • i.e. headline sales growth, EBIT %, or FCF expected.

b) Build a model for the process.

• A simple excel model will do here in 90% of cases.

• The math is not complicated

• The stakeholder set is small

• If your dimension count is too big for Excel, you got Step 1 wrong

• Make sure your model allows you to run scenarios. Add or cut building blocks or organizational units identified in step 1.

• This will be vital later.

Once you are sure the process is well defined and everyone is well briefed, you need to let the team do its job.

Business lead for each key input working with their designated finance partner to:

a) Build sensible assumptions

b) Quantify risks

c) Evaluate investments

d) Generate and quantify initiatives

Keep a close eye on progress, and don’t accept any slippage.

If they’ve got time to eat and sleep, they’ve got time to engage in the LTP process.

If you struggle to get a business lead to engage then there is one line that always works:

“No problem, I’m happy to set your targets for next year’s bonus if you are too busy.” Then give them a stare down, with a white hot intensity that says “I’m going to make your life a misery if you don’t play your part.” Works every time. There’s always one.

Step 3 - Iterate Model

Once you have your inputs from stage 2 there be a patchwork quilt of assumptions.

A good start point, but likely there will be conflicts between different assumptions:

• A sales plan that doesn’t quite marry with the operational plan.

• A cost base that isn’t reflective of the extra activity in the business.

• A plan that asks for a 50% reduction in scope 1 & 2 emissions but doesn’t build in the investment needed to deliver this

• etc etc

This is where short feedback loops and rapid iteration is important.

The key for this stage is to resolve conflicts in the assumptions. These are the trade-offs I was talking about earlier.

Finance have to facilitate the discussion, but not answer the questions.

This is where so many LTP (and budget processes) go wrong.

These conflicts aren’t resolved, and the plan is a plan in Excel, but is not executable in real life.

There is no template answer for how to deliver this, as it depends on the issue / situation.

But this is how I do it most often...

Get the relevant business owners in a room. Present the model outputs, and then challenge each assumption (one by one) with the Group.

This needs to be done at the right level.

If you organized your LTP by business unit, then each business unit will be a separate component process, led by the BU CFO.

This may need several sessions, and more scenario modeling. It could also mean stepping back to stage 2 to recut assumptions, and then regroup. Rapid iteration.

At the end of this stage you need to seek a ‘wedding vows’ moment.

Where all people involved with the process agree that they are married to the plan.

This is powerful to do with everyone in the room together. Make sure they all feel the burden of not wanting to be the one to have dropped the ball.

Think of it like ‘speak now, or forever hold your peace.’

By the end of this stage you should have a well populated model with sensible but stretching assumptions. And a plan that the senior team has agreed to get married to.

Step 4 - Run Corporate Scenarios

In steps 2 & 3 you’ve opened the process up to the business. To make sure you have a well populated model, and a well engaged leadership team.

Now it’s time to close it down again.

Bring it back to the small Group you used in stage 1; CEO, CFO, Corporate FP&A team.

Time to ask the big questions:

• What investments should you make or not?

  • Your model will have identified the universe of investment opportunities. More than you can afford

  • Your model should allow you to play with these, switch them on, and off.

  • Which should you do and which should you not?

  • Try ranking them on the ratio of $ NPV generated per $ of Invested Capital. Top to bottom

• Are there any portfolio changes needed?

  • Is there any M&A to be assumed (even if not specifically identified)

  • Any divestitures?

  • Joint Ventures

• What are the consequences for the financing?

  • Are there any required refinances?

  • What would that refinance look like? Structure & cost.

  • Important now as businesses roll off of cheap fixed debt. And into the new interest rate environment

Again this will need rapid iteration. But now with a corporate lens rather than a business unit lens.

You should be able to boil this down to the 2-4 different scenarios or trade-offs. The preference between those will come down to the judgment on what the plan should be optimized for?

• Equity value at the end of year 5?

• Cumulative cash generation across the plan period?

• Market share?

• Carbon reduction?

• Etc, etc

These will all likely generate very different decisions on portfolio, investments and financing.

Any CEO or Board of Directors will tell you they want all those things.

But this is the moment you find out which matters the most.

When you are clear on the scenarios, you need to built that narrative into a good quality pack for the Board. Present the choices.

Step 5 - Make Decisions & Communicate

You've presented the LTP process and scenarios to the BoD, and had a thorough debate. You should be able to reach clarity on which is the preferred route.

It is important the CEO & CFO ensure the Board don’t invent other scenarios that are not practical, at this stage.

But ... there is nothing wrong with going back to the process to iterate for a valid scenario. It’s pretty common that it needs more than one board meeting for this reason.

Once you have a confirmed scenario, you need to lock this in.

This means communicating the output of the process to the wider stakeholders. BU leadership teams, department VPs, etc.

Whilst also being mindful of any sensitivities especially with M&A.

…that’s your LTP!

Next time we’ll talk about Year 1 of that LTP and how it becomes the start of the budget process.

BOOK CLUB

As thousands of people travel to Omaha for the Berkshire Hathaway AGM, we give the stage to Warren Buffett.

Check out The Essays of Warren Buffet: Lessons for Investors and Managers as edited by Lawrence A Cunningham.

There are many books out there on Buffett’s writing. What I like about this one is two things:

1. It focuses on a number of interesting accounting topics; stock based compensation, fallacy in acquisition accounting, the definition of owner earnings, etc

2. It sorts the writings by topic rather than chronology

This leaves you with a really tightly edited, but deep analysis into a few interesting topics, with a chapter for each.

Enjoy!

FEEDBACK CORNER

I’ve got good news for the person that wrote this review last week:

THIS WEEK ON TWITTER

I wrote an impromptu tweet whilst sat in the car. And before I knew it, 150k people had seen it. Twitter is wild.

POACHED GREG

So far, Greg’s story in season 4 is one of a slow and awkward embrace of the role of a$$hole. I’m excited to see where it ends up.

Probably with greg on his face.

Anyway …

That’s all for this week. As always you can find me here on CFO Secrets, Twitter, & LinkedIn.

Long Term Plan this week, Budgets next week. Sounds like my day job.

Until next time…

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 to make the right decisions.