Over the past 10-15 years, the role of the financial officer has changed dramatically. Now, he can better manage risk and analyse alternatives thanks to the rapid development of securities and tools available to them. Similarly, financial officers are more knowledgeable about what modern financial theory is, its implementation and shortcomings. They have realised how much finance and risk management add to the value of business. Similarly, modern CFOs are better equipped to communicate with financial market and tilt it in their favour.
Despite all the facilities and tools available to CFOs, they are still committing some very common mistakes. Some of these mistakes happen due to the lack of required skills while other are based on the misconceptions in the CFOs office or permeate throughout the organisation.
Following lines explain some of the most common mistakes committed by modern chief financial officers.
Mistakes in Capital Budgeting:
Some of the most basic and common mistakes committed by CFOs are about Capital Budgeting. The first of these mistakes is the over reliance on the spreadsheets. For instance, the financial officers decide in favour of taking projects if the spreadsheet indicates positive Net Present Value (NPV) and the IRR exceed the cost of capital. However, they never try to find out why the NPV is positive or how IRR exceed the cost. Some financial officers also use spreadsheets to make a project look good and profitable.
Similarly, there are very few companies or financial officers who actually follow up on projects to ensure whether actual cash flows are in consistent with the expectations. They never take any action to eliminate differences if there are any. Most importantly, risk management is often on the bottom of their priority list.
Capital Structure Mistakes:
In addition to Capital Budgeting, the capital structuring mistakes are also very common. In fact, most financial officers are unable to maintain minimum or maximum level of debt required for the survival and progress of the company. The companies have either too high or too low debt or it is greater than the assets detained by financial organisations as securities. Furthermore, profitability dictates the capital structure of most of the firms which is also a mistake. In general, all the above mentioned factors contribute to the increased financial troubles of the firm.
Merger and Acquisition Mistakes:
Mergers and acquisitions are very common in modern business world. Every other day, you hear about a big company acquiring a small one or two industry giants mongering with each other. It is also a fact that all but few mergers or acquisitions prove to be complete disasters or fail to realise their true financial potential. There are many factors which are responsible for the problems mergers face and financial mistakes on the part of CFOs are most important of them.
The First and foremost question is that why such deals are done in the first place? If two companies are operating profitably as independent entities, there is no need to merge. Similarly, some companies acquire the underperforming firms in a hope that they can improve management and finance system of the target firms and make them profitable. In some cases this strategy is successful but most often, it puts unnecessarily extra financial burden on the buying firm.
Finally, when mergers and acquisitions happen, financial officers are far more likely to think that these transactions can add value to both organisations but in fact, there analyses are usually based on assumptions rather than reality. Most importantly, officers are not willing to learn from the past mistakes and are likely to repeat them in future.
Risk Management Mistakes:
Last but not the least, CFOs regularly commit mistakes when it comes to risk management. In this regard, the biggest mistake is to think is silos. Most often, their decisions depend on what is happening in the firm’s treasury or how the treasurer evaluates the entire situation.
The second mistake regarding risk management is to base decisions on the predetermined view of the market. Sometimes financial officers are pretty sure of what is going to happen to interest and exchange rates or commodity prices. They don’t take into consideration the various market indicators about which way market will move. As a result, their decisions often fail to produce the desired results.
Finally, have CFOs ever tried to find out how much these mistakes cost to the firm they work for? Although, it is hard to quantify the price of making these mistakes yet most experts believe that it is quite substantial. It is also pertinent to note that some of these mistakes are easily avoidable. CFOs only require changing their corporate mindset and compensation policies to prevent these mistakes.