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The term strategy fits well in many business contexts. Most agree the areas of marketing, sales, and mergers and acquisitions are paced by strategies of sometimes significant depth and breadth. Strategizing the finance function, however, seems awkward. The culture of business implies that the accounting/reporting function is far too objective to allow for strategies. The numbers are what they are, and put
ting them on paper is simply a perfunctory, administrative task.
Business owners and executives are focused on growing the business and achieving success. Because decisions are only as good as the information on which they are based, establishing a reliable pipeline of financial data from the business environment is crucial. Unfortunately, neglecting administrative functions (like the finance function) is common when companies are experiencing success. Who needs answers and analysis if everything is going well? This seems logical until the organization faces challenges. The seasoned executive will attest to the fact that many seek solutions/answers only when problems arise. It is imperative at this point that accurate information be readily available. Many businesses, however, accept mediocrity when it comes to the quality of data and their decision support system. They deal with the here and now and worry about problems only when they arise, resorting to knee-jerk or ill-fated short-term fixes. This is often the case with public companies when they are faced with a crisis of earnings. The next example illustrates this point:
Sentec is a multinational manufacturer of electronic components whose stock is traded on a major exchange. Its success lies in its ability to utilize low-cost foreign manufacturing sites to produce electronic components for the hightech computer industry. Although its business is sound, its data flow dynamic is weak, relying on outdated software packages and manual processes to gather and process actual results as well as budget and forecast data.
Sentec’s warm relationship with Wall Street hinges on its uncanny ability to achieve earnings expectations, which are consistently set at a growth rate of 20% each quarter, a target it has hit for 21 straight quarters. The atrophy in its budget and forecasting capability has been brought on by this simple, easily articulated goal. The arduous, error-prone closing process is shored up by regularly truing up the actual results with small, seemingly immaterial adjustments to get them in line with the forecasted expectations.
When Sentec’s major customers experienced a bump in the road due to a softening economy, an interesting thing happened. Customers began releasing data to the Street indicating lower-than-predicted earnings for the next few quarters. Sentec, having no evidence to the contrary, saw no reason to adjust its own earnings estimates. Management felt that unless lowered results could be quantified in detail, there was no sense in putting out lowered earnings expectations. They felt that at the least they would be misleading the public; at worst they would be derelict in their duties by putting out inexact information that could damage the upward momentum in stock price they worked so hard to establish. In spite of the sympathetic mood of the analyst and investor community, Sentec stood its ground and passively sent the message to the Street that the 20% growth would continue.
As predicted, Sentec’s customers experienced the soft quarters they had predicted, some with more accuracy than others. The first quarter subsequent to their customers’ initial soft quarter resulted in dismal results, and the auditors would not sign off on any adjustments linking actual results to forecasted results. This left management with the unenviable task of packaging the bad news and presenting it to the Street. Sentec executives insisted that they would have to enact a plan that included permanent reduction in the job force and plant closings. They knew that the poor earnings would be hard enough to communicate, but poor earnings with no plan of action would be worse.
When the news was announced, the stock price dropped almost 40%. The executive team, however, was lauded for its plan to reduce the company’s global workforce by 20%. A year later Sentec’s customers recovered along with the economy. Unfortunately for Sentec, though, the year saw a steady decline in its customer base as the workforce reduction and plant clos ings curtailed its ability to meet the heightened demand of customers it could easily address in the past. A slow erosion of the stock price and an eventual delisting from the exchange on which it had been traded for years resulted.
Executive teams throughout the business community face challenges like these all too often. Without the benefit of hindsight, business leaders are forced to balance the demands of stakeholders (shareholders, customers, employees, etc.) in a dynamic business environment. Could Sentec’s management have prevented the large slide in stock price? Should the drastic cuts in workforce have been avoided? No one knows for sure how a different approach to management’s course of action would have impacted the company. Key areas of note, however, are:
- Why couldn’t Sentec’s actual results be released as accumulated? The fact that Sentec’s management was adjusting the actual results to meet Street expectations exposed two areas of concern: (1) the propensity of management to meet unrealistic expectations at any cost and (2) a weak finance function. Should management be focused more on the well-being of the organization or how it is perceived? No doubt both, and in that order. In this case, though, Sentec’s management seemed comfortable with a form-over-substance finance model. The consistent gap between Sentec’s forecast and actual results is indicative of a weak finance function. The fact that the company relied on forecast data as the actual results when the two differed implies that management was preoccupied with the needs of the Street over those of the finance organization. These are manifestations of the quarter-to-quarter thinking that is predominant in many public companies.
- Why did Sentec have a poor or nonexistent forecast process? Why was the company consistently off the mark when it came to hitting the forecast? Even though the closing process was poor, the fact that the company regularly missed its forecasts was more a function of a weak forecasting process rather than a poor closing process. Growth models that show steadily climbing earnings may be realistic in the short term or very long term, but rigidly consistent growth models are unrealistic. Not experiencing a spike in either direction as it relates to earnings for 21 quarters is suspicious if not outright impossible. Did Sentec have a real forecast that predicted the future with relative accuracy (that management chose to ignore), or did the forecast and budgeting process consist of applying a 20% growth rate to the actual results of the prior period?
- Why didn’t Sentec foresee the decline in customer demand? Why was management so oblivious to the environment, in particular the state of the economy and the disposition of its major customers? Forward-thinking companies employ business models that address the impact of softening demand, including the unlikely event of losing major customers. Had Sentec ever considered how it would react to a sudden drop in demand for its products? The finance organization must have a handle on events that could lead up to volume demand shifts and dips in cash flow as well as a plan to counteract them.
- Why did Sentec not build contingencies into the business model? Did the company adequately protect itself against poorly performing customers? Doing so may be as simple as seeking a diversification in customer base or booking adequate reserves on the balance sheet. Companies often become complacent when they have a steady flow of revenue from a small number of “big” customers. This is frequently the case with businesses that rely on government contracts. Getting a little business from a lot of customers is more often than not safer than relying on a lot of business from a few customers. Although this business model takes more work to cultivate, it lends more security to the business in the mid to long term.
- How could Sentec not have known what plant closures and headcount reductions would mean in the long term? Taking a swipe at infrastructure is gratifying at first and looks good to the analyst community, but what does it mean in the long run? How would this impact capacity and quality of production in the future? A company must understand the ramifications if operations are pared back. Sentec may have been able to mitigate the challenges of meeting future, increased customer needs by temporarily reducing the workforce. This would have given the company a good story to tell the Street while leaving its options open for the future. Another alternative would have been to leave everything as is and weather the storm for a time until the economy recovered. Because the company acted rashly, it sacrificed the future for instant gratification.
- Why did Sentec rely on a quick fix? It is debatable whether Sentec’s management chose headcount reductions and plant closings as a proactive approach to managing earnings or as a knee-jerk reaction to the marketplace. One could make a reasonable argument either way. It is clear, however, that Sentec had no grasp on the effect plant closings would have on future operations. The health of operations took a backseat to the expectations of the Street. Management was feeling the pressure to dampen the impact of poor earnings on the stock price. This is an example of how short-term solutions can create long-term difficulties.
- Why did Sentec let the environment dictate circumstances? The fact that Sentec’s management reacted in knee-jerk fashion to its poor earnings is indicative of a reactive management style. Although no one can predict the future with certainty, Sentec was lulled into a false sense of security with its 21-quarter string of 20% growth. The company slumped into an if-it-ain’tbroke-don’t-fix-it posture and failed to enhance the finance function during this 21-quarter period when demand for information was light. Whether it was shortsightedness, overconfidence, or presumption that created the problem, management’s actions doomed the company. The reality is that if businesses are not in a state of continuous improvement, they are moving backward.
- Did Sentec lose confidence in its ability to analyze? Although speculative, it appears that Sentec’s management had no confidence in the finance function’s ability to analyze data. This seeming lack of confidence could have precipitated the reactive decision to reduce headcount and close factories. Was lack of confidence due to a prevailing opinion that the finance function was weak? Perhaps the organization minimized the finance function, seeing it as a strictly non-value-added function. Regardless, management must have confidence in the ability of the finance function to provide input on operational decisions. An attitude of inclusion regarding the finance function ultimately begets the need to build it up. This is a healthy approach by management that forces the organization to focus its resources toward its lifeblood—information flow.
The myopic thinking that prevailed at the executive level of Sentec ultimately destroyed it. No company makes short-term thinking a matter of policy; however, a lack of awareness of certain aspects of the business—in this case the finance area—can force management into a reactive and short-term posture. To gain an appreciation for how strategizing the finance function can protect the organization from short-sightedness, the benefits of strategy must be understood. | 
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