While chief executive officers aren’t specifically charged with managing the company’s accounting and budget, they can benefit from strong financial acumen. Having command over financial concepts can be a powerful way for CEOs and other non-financial executives to help drive responsible business growth and create incremental value.
It’s important, at the core, for CEOs to understand how value is created. As McKinsey & Co. has stated, value creation is a function of growth and returns on capital. Value is created by improving cash flow, not by financialization—or a rearrangement of claims on cash flows—which is what happened in the securitized-debt market leading up to the Global Financial Crisis. A lot of parties sliced and diced the pie, creating financial instruments and believing risk was reduced. However, we know that there was no real creation of value (i.e., increase in cash flow or assets) or reduction of risk; the risk was merely passed on to other investors.
Let’s review how a CEO’s understanding of certain finance essentials could help with better decision-making and value creation, leading to a greater ability to leverage financials to execute vision.
- There is no need for CEOs to do their own accounting, but they should manage the various elements of financial reporting and learn how they are connected. Understand where metrics are now and where they should be, including statistics such as gross margins, overhead costs, and assets and liabilities. These are numbers that the company’s stakeholders and Board members are interested in. Additionally, CEOs should have a solid grasp on key performance indicators (KPIs), through which they could measure performance and compare it against strategic and operational objectives.
- It’s important to understand where money is coming from and how it’s moving, especially if and when it comes time to raise more of it. Develop a capitalization strategy, which may involve debt and/or equity financing. Knowing how and when to seek increased capital will help a CEO and other executives avoid poor financing decisions and resist the call for excessive leverage, especially in an environment of cheap and easy lending.
- Finance is part of every business plan. Strategic initiatives will impact, and will need to be supported by, financial resources. This means a CEO or non-financial executive, perhaps in partnership with a CFO, should think in terms of assessing the potential profitability of strategic initiatives and/or investments. Once a strategy is established and implemented, stay close to the plan to monitor and to make adjustments along the way.
- Certain risks may not be mitigated or eliminated, but many can be managed. Consideration of downside risk, financial or otherwise, should be a fundamental part of a CEO’s analysis of projects and of the organization as a whole.
The above list isn’t intended to be exhaustive, and there are practical limits to what a CEO can or should reasonably undertake in the realm of finance. There are CFOs and finance teams, after all, who are dedicated to understanding and applying technical analyses to all corners of an organization to ultimately support company performance. A CEO’s knowledge of value creation, grasp over current financial conditions and projections, and ability to think in terms of risk control will go a long way in helping leadership make sound, independent business decisions.