How to speak like a CFO
Too often, finance executives in corporate America simply don't believe that purchasing departments are really bringing in the savings they claim. That may be because finance and purchasing don't speak the same language. Here's how to get credit for the savings you achieve by expressing them in terms finance will understand.
By Paul E. Teague -- Purchasing, 5/4/2006 2:00:00 AM EDT
"Show me the money."
That legendary line from the 1996 movie classic Jerry Maguire echoes from finance departments all the way down the halls of corporate America. But nowhere is it heard louder and clearer than in purchasing, which daily squeezes costs out of projects and processes.
Too bad finance doesn't believe it.
"Savings get lost in corporations too easily," says David Hope-Ross, director for procurement applications at Oracle in Redwood Shores, Calif.
Where do they go? In the guerrilla-war reality of departmental budget management, managers simply spend savings on other projects before finance even sees them.
And in some cases when finance sees the savings, they're not sure what to make of them. One problem could be the savings themselves. "Procurement sometimes takes credit for softer savings, like process efficiencies with no real headcount reduction, or cost avoidance—getting agreement to not pay for something that was in a contract," says Brett Mauser, director of global procurement for Dayton, Ohio's NCR and an Oracle user.
That means purchasing has to adopt a financial mindset and vocabulary to get credit for the savings they bring. Here are some suggestions:
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First, make sure you understand profit and loss statements and working capital, says Hope-Ross. "CFOs want to use procurement as a financial-management tool," he says.
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Learn how costs are developed in your company so you can make informed decisions on cutting them, says Michael Horricks, corporate purchasing and materials management at Clemmer Steelcraft Technologies in Waterloo, Ont.
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Don't talk about cost avoidance. Says Chris Sawchuk, leader of the procurement practice at researcher The Hackett Group: "Translate your cost savings into profitability."
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Similarly, talk about how you're increasing your company's competitiveness, advises Dennie Norman, principal strategist for worldwide marketing at SAS.
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Think in terms of risk. For example, says NCR's Mauser: "Understand what inventory does to a company's return on assets and cash flow, and know how to assess the mergers and acquisitions."
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Understand return on invested capital (ROIC) and earnings per share. "Those concepts drive C-level attention because they are what Wall Street and bankers are interested in," says Bob Rudzki, president of Greybeard Advisors of Pittsburgh.
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And report your savings regularly.
Actions like that, and others, could go a long way toward winning over tough finance experts like Bob Calderoni. Now the CEO of spend management firm Ariba in Sunnyvale, Calif., earlier in his career he was the CFO of manufacturing company Avery Dennison in Pasadena, Calif. "Purchasing always claims great savings, but when I was a CFO I couldn't find them in the P&L," he says.
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Here is a list of financial terms purchasing executives should be familiar with, according to Robert Rudzki, president of Greybeard Advisors and co-author of Straight to the bottom line: 1. ROIC (Return on Invested Capital): earnings divided by the total capital invested in the business (long term debt plus stockholder equity) 2. Cost of Capital: the weighted average "cost" of debt and equity. It represents what you must earn to, minimally, cover the expectations of your debt holders and stock holders 3. EVA (Economic Value Add): if ROIC is greater than Cost of Capital, then EVA is positive (you are adding value to the organization). If ROIC is less than Cost of Capital, then value is being destroyed and - absent substantial corrective action - the demise of the enterprise is just a matter of time 4. EPS (Earnings per Share): the net income divided by the # of common shares outstanding. Typically calculated on a quarterly and annual basis. 5. P/E Ratio: The ratio of the common stock price to the annual earnings per share. Companies/industries typically "enjoy" certain P/E ratios, therefore, increasing the E (earnings) often directly equates to a higher stock price. The two "biggees," says Rudzki, are ROIC and EPS. Those two concepts drive C-level because they are what Wall Street and bankers are interested in. ROIC and EPS are the ultimate "report card" of senior management. |
The numbers game
Linda Peyton, director of procurement technology for Blyth, Inc., in Greenwich, Conn., knows how to help finance find savings. Not long ago, she made a presentation to the company's executive steering committee on the value of some cost savings her department hoped to realize through its use of technology from SAS and Procuri. Her goal: show how many additional sales it would take to equal the cost savings she hoped to introduce, and what the impact would be on earnings per share.
"We were talking about a hypothetical $1.6 million savings over 12 months on a $15 million spend," she recalls. "I interviewed our sales and finance people to determine how much in additional sales it would take to create an equivalent EBIT (earnings before interest and taxes). The answer was, depending on product line, about $3.6 million in sales."
Result: "A better understanding by senior management that the costs savings through procurement technology were a real bottom-line benefit to the company," she says.
Peyton is not alone in using her financial acumen to show the value purchasing can bring. Greybeard Advisors' Rudzki has built a career on his ability to mesh finance and purchasing goals.
Several years ago, when he moved from finance to procurement at Bethlehem Steel in Pennsylvania, he noticed that no one had paid attention to the company's payment-terms profile, which was net 30 days. Payment terms have a direct effect on cash flow. Delaying payment can improve present cash flow, but can earn companies a reputation as late payers who wind up paying more for materials and components as their suppliers try to recover the value of the cash withheld. Paying early can earn discounts but temporarily drain cash flow. So, in an effort to help purchasers strike the right balance and bolster purchasing's savings efforts, he developed among other things a payment-terms evaluation matrix that allowed every procurement person to easily compare any set of terms and their effect on cash flow to any other set of terms. It was one of the first big-company initiatives on improving payment terms in the U.S., and he later developed a similar matrix when he became CPO at Bayer.
Rudzki recently co-authored the book Straight to the Bottom Line.
Record the savings properly
One major disconnect between purchasing and finance is in the way the two groups record savings. Procurement assumes savings for 12 months, says Mauser, but accounting standards are updated annually. "That means the savings carried into a new year don't show up in the purchase price variance," he says.
Additionally, procurement traditionally records savings for capital items when the spend occurs. "But," says Mauser, "the savings show up in the P&L in the depreciation expense over the life of the asset."
Marc Marini, managing director of global procurement services at New York's Merrill Lynch, has developed a five-step process to deliver savings in his $3.5 billion spend. The process tracks purchases from project identification to request for proposal and contract documentation, vendor evaluation and negotiation, contract award and vendor/contract management. He rates each acquisition or deal by which step his team is involved in. He tags savings, which are validated by finance, to each deal and reports the results to senior management.
Additionally, Marini publishes a quarterly executive summary on key accomplishments and the number of deals, savings, spend influenced and details on governance (contract compliance). "Through these reports and results from the five-step process," he says, "we show that sourcing obtained 15% savings in deals where we are involved early, but only 6% when we're not."
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Tracking your savings process is essential for ensuring that you actually achieve savings and convincing CFOs and other C-level executives of the same. Here is the five-step process Marc Marini, global procurement director for Merrill Lynch, developed. The process tracks purchases from project identification through contract award and supplier management. Click here to download the presentations: Presentation 1Presentation 2 |
A former CFO for technology at GE Capital, Marini instinctively speaks the language of finance and understands how to get finance's attention. In fact, in his CFO days, he was skeptical of purchasing's savings claims too. "At GE, purchasing would say it brought $150 million to $200 million in savings, but we in finance didn't know what that meant and we were skeptical that it benefited the bottom line," he says.
He brought that skepticism with him when he first went to Merrill Lynch, where he discovered early that the firm had lost control of its dealings with outside consultants. "There was no central database and there were no enforceable contracts," he says. "After a major effort to collect information, we were able to show the chief technical officer he was using more consultants than he thought he was using and over 60% were paid over the street price."
Result: Purchasing got control of all spending on consultants. "We were able to consolidate our vendor base from 100-plus firms to 25," Marini says.
Analyze this
Analytical skills like that and familiarity with such concepts as net present value, return on investment and make vs. buy analyses are important for purchasing professionals, says Tony Santiago, vice president of global sourcing and supplier management at Bristol-Myers Squibb in New York.
Like NCR's Mauser, he believes that cost reduction, not cost avoidance, is what resonates with financial officers. "What they want to see," Santiago says, "is the measurable impact on the operating base of the company, and cost reduction that aligns by profit-and-loss-statement line items does just that."
Santiago knows what finance is interested in because he was previously a finance chief for the pharmaceutical manufacturing division. "I would tell business-unit leaders that they couldn't meet their numbers if they didn't take purchasing seriously because 50% of the sales base was third-party purchases," he says. "How to better manage supplier spend—both from the price the company pays and from consumption and right-sizing specifications—is now an important focus for procurement and business as well."
That approach shows Santiago's belief in using the concepts of supplier relationship management and consumption and specification management to capture suppliers' innovative ideas and to drive higher levels of cost reduction, while at the same time being consistent with finance's focus on productivity. He encourages purchasing professionals to understand their suppliers' economic models, including their profitability and the dynamics of their industries.
And, he and his team encourage suppliers to think through their respective cost structures and price points before bidding on their business. "We don't want to do business with suppliers who price so low that they don't make a fair profit," Santiago says. "That's a short-term solution that usually ends up in supply or service issues, and disruption to the business."
That's a situation finance professionals are desperate to avoid. Purchasing can help them avoid it by understanding their language and their concerns.
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