Optimal Capital Allocation Strategies: CFOs Pondering Business Systems…

Optimal Capital Allocation Strategies: CFOs Pondering Business Systems…




What are the roles of CFOs? How do firms determine the optimal capital allocation strategy- best mix of debt, equity, and internal financing that maximizes the return on invested capital? How do firms choose their capital structure? How do firms align and integrate their business systems and processes to ease learning, coordination, collaboration, and innovation? These strategic questions relate to business systems agility and resilience in disturbing, emergent and dynamic circumstances; and the optimal capital allocation strategies and capital structure of a business enterprise-the appropriate mix of debt and equity that maximizes the return on investment and shareholders’ wealth while minimizing the weighted average cost of capital (WACC), simultaneously.

While disruptions often show the possible vulnerabilities of business systems, processes, and procedures, they also provide insights into business agility- capacity for rapid change and for flexibility in operations and resilience- ability to anticipate, retrieve from disruptions, emergencies, resist or retrieve quickly from difficult and negative conditions. Clearly, effective capital allocation strategy is vital to a sound business strategy designed to maximize the wealth producing capacity of the enterprise. In these series on optimal capital allocation strategies, we will focus on business systems and processes agility and resilience and provide some functional guidance. The overriding purpose of this article is to highlight some meaningful portfolio of CFOs as we ponder industry best practices in business systems agility and resilience. For specific financial management strategies please consult a competent specialized.

Some Duties of CFOs

CFOs are responsible for firms’ past and present financial health and constitute an integral part of a firm’s senior leadership responsible for financial management-acquisition and allocation of financial resources. CFOs have multiple duties, that include reviewing and presenting financial statements, planning budgets-cash and capital; and deciding where and when to invest firm’s funds. CFOs design, plan and execute the capital structure of the firm-determine the best mix of debt, equity, and internal financing. Addressing the issues surrounding optimal capital structure and allocation is one of the most important duties of CFOs.

Some functional Guidance

As I have already explained, while disruptions often show the possible vulnerabilities of business systems, processes, and procedures, they also provide insights into business systems agility and resilience. The COVID-19 pandemic was not an exception, it tested the effectiveness of firms’ capital allocation strategies, planning and execution. Firms that were able to quickly re-prioritize investments and re-allocate capital have weathered the storm and, in some situations, already improved their competitive position. But a slight majority of CFOs indicate the COVID-19 pandemic had an overall negative effect on their firm’s ability to efficiently and effectively invest capital in 2020. The apparent without of agility and resilience in so many firms call for culture of assessment and opportunities for continuous improvement.

Most CFOs indicate the pandemic has forced them to completely rethink their capital allocation strategy, business financial systems, processes, and procedures. There is gathering empirical evidence suggesting that many firms have embraced far away work based on veritable data on productivity. For example, health care providers have fully embraced telemedicine. Many manufacturers have established new health and safety procedures. The question every firm must now answer is which of the many business form changes are strategic and which are only transactional? Additionally, the COVID-19 pandemic has accelerated some trends that were already in place, such as the push into all things digital. In fact, digital technology, which supports trends such as telemedicine and far away working, is the area were CFOs most frequently indicate investment increased in 2020 vs. 2019.

A meaningful majority of CFOs indicate accelerated digital transformation will impact capital allocation going forward. With so much uncertainty, firms need to weigh the likelihood of various scenarios to determine what their business may look like in the future, and then align their strategy and capital allocation consequently. CFOs must carefully determine what assets and capabilities they have and need. Once the future state of the firm is carefully assessed, then CFOs must take inventory of the businesses and assets in their portfolio. methodic regular portfolio reviews can help CFOs find assets that no longer align with firm’s long-term strategy but can easily be divested to fund future investments.

There is gathering empirical evidence suggesting that the COVD-19 pandemic has forced closer examination of corporate financial portfolios. Indeed, meaningful majority of CFOs indicate they plan consistent review and rebalancing of their portfolios to focus on the chief businesses. Firms should continuously estimate which assets and capabilities within their portfolio will help permit their future-state business form. Should these assets and capabilities be owned because they are at the very chief of the business? Could they instead be acquired by partnerships or purchased from third parties, with the trade-off of giving up some control? Many companies are considering these “asset-light” business models that look to source non-chief capabilities or inputs into the business by strategic alliances, partnerships, joint ventures, collaborations, or outsourcing agreements.

The goal of evaluating whether your firm is the best owner of each asset is to free up capital to invest in the capabilities that will be chief to the business enterprise in the future. Funding future portfolios requires a capital allocation course of action with governance that instills discipline and enables objective decision-making. the time of action must also be nimble enough to adapt to changing business needs. But many CFOs indicate their capital allocation approach is not adequately flexible and regularly updated nor informed with necessary data. consequently, the business financial systems and processes should be methodic, deployed and integrated to ease learning, innovation, and continuous improvement.

There is material empirical evidence suggesting that already when the time of action is methodic, more than a simple majority of CFOs indicate their capital allocation course of action is not always followed. consequently, less than half of CFOs indicate they can quickly estimate market threats and opportunities and reprioritize planned investments consequently. This can hinder long-term shareholder returns as only slightly less average number of CFOs indicate their capital allocation course of action is successfully helping them unprotected to their Total proportion Return (TSR) goals-a measure of financial performance, suggesting the total amount an investor reaps from an investment-specifically, equities or shares of stock. In practice, TSR factors in capital gains and dividends when measuring the total return generated by a stock. The formula for calculating TSR is { (current price – buy price) + dividends } / buy price. TSR represents an easily understood metric of the overall financial benefits generated for stockholders. consequently, TSR is a good indicator of an investment’s long-term value, but it is limited to past performance, requires an investment to generate cash flows, and can be sensitive to stock market volatility.

course of action Alignment and Integration

Extant academic literature and best industry specialized practices suggest that in firms with aligned and integrated business systems and approaches, operations are characterized by repeatable processes that are ordinarily evaluated for continuous improvement. Learning is shared and there is deliberate coordination among all business units. Further, processes to pay attention to meaningful strategies and goals and are regularly evaluated for change and continuous improvement in collaboration with various business units. The firm so aligned and integrated seeks to unprotected to efficiency, quality, innovation, and customer responsiveness across all functional areas of the business enterprise by examination, innovation, and sharing of information and knowledge management designed to create and continue competitive advantage in the global marketplace.

Processes and measures track progress in meaningful strategic and operational goals. Aligned and integrated processes require consistency among plans, processes, information, resource decisions, workforce capability and capacity, actions, results, and analyses that sustain meaningful system-wide goals and strategic priorities. Effective align­ment requires a shared understanding of shared purposes, basic roles, and goals. It also requires the use of complementary measures and information to excursion planning, tracking, examination, learning, innovation, and continuous improvement at all levels. Effective alignment and integration require harmonization of plans, processes, and knowledge management to sustain meaningful system-wide goals. consequently, effective integration goes beyond alignment and is achieved when the individual elements of a firm’s performance management system function as a fully interconnected unit. Functional adaptability is the measure of matured business systems and processes.

Agility and Resilience

Best industry specialized practices suggest agility and resilience require business leaders to know, understand and anticipate emergent business challenges, stay flexible to adapt to shifts in the global marketplace and begin change in their firms. It’s the dynamic business enterprises that have a much better chance to survive – and already to thrive – in the shifting global business ecosystem. Further, agility and resilience relate to the firm’s ability to plan, anticipate, prepare for, and retrieve from disasters, emergencies, and other disruptions, and protect and enhance workforce and customer engagement, supply-network and financial performance, firm’s productivity, and community well-being when disruptions strike.

Additionally, resilience requires agility throughout the firm and goes beyond the ability to return to position quo ante when disruptions appear. In practice, resilience method having a plan in place that allows the firm to continue operat­ing as needed during disruptions. To unprotected to resilience, business leaders must cultivate the agility to respond quickly to both opportunities and threats, adapt strategy to changing circumstances, and have strong governance with a culture of trust. nimble and resilient firms adopt an ecosystem mindset, embrace data-high thought processes, and equip their workforce with current learning of new skills and align business systems around basic roles.

In sum, changes in customer requirements, uncertainty over the speed of the post-pandemic recovery, challenges in developing accurate forecasts, and the need to decide which changes accelerated by the COVID-19 pandemic are strategic and which are transitory all point to the importance of culture of assessment and continuous improvement in the capital allocation systems and processes. While most CFOs indicate they review their capital allocation course of action yearly, only few perform gap examination and regularly analyze how the time of action needs to be alternation.

Given the speed of market dynamic, firms should be strive for a capital allocation course of action that is fully aligned, integrated and inventive. The capital allocation course of action should not end when decisions are made. During implementation, CFOs and their teams should verify that the assumptions made around the investments are proving out or require in-flight adjustments. After implementation, governance should also call for gap examination to determine the effectiveness of the allocation strategies and then incorporate those learnings into future investment decision-making. A clear majority of CFOs indicate their course of action framework and governance, and project monitoring and review are only slightly or not at all effective. These challenges can hinder business financial system agility and resilience during disruptions and changing market conditions, leaving firms unprotected and unable to pivot when needed.

Firms should utilize progressive tools to gather and analyze data. meaningful performance indicators (KPIs) are being evaluated on more metrics than ever before, both quantitative and qualitative. For example, sustainability metrics are now basic and go beyond revenue and profits but also address the social and environmental impacts of business strategies and decisions. Missing meaningful industry benchmarks on any of these metrics can imperil earnings, firm’s reputation, and long-term value creation. without of data and examination capability are among the most cited barriers to optimal capital allocation. All decisions must be data pushed if firms are to create and continue competitive advantage in the applicable market segments.




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