The Real World of finance TEAMFLY Team-Fly ® The Real World of finance 12 Lessons for the 21st Century JAMES SAGNER John Wiley & Sons This book is printed on acid-free paper. Copyright © 2002 by John Wiley and Sons, Inc. All rights reserved. Published simultaneously in Canada. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 750-4744. 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ISBN: 0-471-20997-X Printed in the United States of America 10 9 8 7 6 5 4 3 2 1 For Stephen, Amy, and Robert-Paul Lesson Title vii vii Acknowledgments ix Introduction 1 PART 1 Managing Financial Activities 15 Lesson 1 Profitability 17 Lesson 2 Working Capital 33 Lesson 3 Financial Responsibilities Outside of Finance 47 Lesson 4 Outsourcing 63 PART 2 Financing the Corporation 79 Lesson 5 Access to Credit 81 Lesson 6 Noncredit Banking Services 99 Lesson 7 Strategic Planning and Capital Budgeting 114 Lesson 8 Rating Agencies 127 Lesson 9 Investment Banking 141 PART 3 Facing Twenty-first Century Challenges 157 Lesson 10 Audit and Control 159 Lesson 11 Risk Management 176 Appendix 11A Guide to the Preparation of Policies and Procedures 187 Lesson 12 The Chief Financial Officer’s Focus 192 Afterword 206 Index 209 contents Lesson Title ix ix T his book developed from my teaching and consulting expe- riences going back three decades. Working with Fortune 500 clients, I have been constantly amazed that finance is almost an afterthought in the everyday world of business—except, of course, for such financial services companies as banks and se- curities firms. Business today focuses on three priorities: ■ Sell product. ■ Install and maintain information systems to tell management where it is and where it may be going. ■ Make profits. Finance is expected to provide permanent capital for in- vestments and to manage working capital to meet ongoing requirements. But it is not supposed to get involved in the man- agement of the business. If you don’t believe this, visit the fi- nancial function of a company and ask if any senior manager has ever gone on a sales call, toured the manufacturing floor, or talked to an unhappy customer. When I teach finance courses, I often explain that although the book says “X,” the real world operates in a “Y” mode. Stu- dents without significant work experience don’t understand this. Those who are in corporate positions, usually part-time MBA students, immediately agree. And the question always is: Why doesn’t someone write a book based on reality? My gratitude goes to all of the students and managers I have encountered over the years. They have educated me to a far greater extent than I have ever taught or advised them. I specif- ically acknowledge the following: acknowledgments x ACKNOWLEDGMENTS ■ My first finance course at Washington & Lee University, taught by Professor Leland McCloud, using the text The Financial Policy of Corporations, 5th ed., by Arthur S. Dewing (New York: Ronald Press Co., 1953). ■ Rosemary Loffredo, assistant treasurer of International Paper, who was my copresenter of an early version of this topic at the annual Association of Financial Professionals in Chicago on October 15, 2001. ■ Timothy Burgard, my Wiley editor, who shepherded this book through to publication. Grateful acknowledgment is extended for the permission granted by the following publications for the use of lesson 12 material that originally appeared in somewhat different formats. ■ To the Association of Financial Professionals for “Roles of the CFO in the 21st Century,” AFP Exchange, September/October 2001, Volume 21, Number 5. ©2001, pages 70–78; all rights reserved. ■ To Financial Executives International for “Today’s Treasury Function,” Financial Executive, January/February 2002, Volume 18, Number 1. ©2002, pages 55–56; all rights reserved. For any and all errors, I am entirely responsible. [...]... not even discussed in the classroom Examples of these changing issues include company profitability, audit and control, the external focus of the chief financial officer (CFO), financial responsibilities outside of the finance organization, commercial and investment banker relationships, and the role of the rating agencies This book discusses these challenges in the context of the twenty-first century... technologies 4 THE REAL WORLD OF FINANCE The use of invalid financial concepts is a significant problem in the current environment of evolving business complexity Finance is experiencing rapid change through the development of sophisticated management tools that repackage traditional instruments or risks into their component elements This repackaging allows the transfer or sale of each portion of the risk... reflected in the Enron story Because of the limitations of the book, we are not discussing other considerations: ■ The sad stories and lessons for the twenty thousand jobs and retirement plans put at risk by these actions 11 Introduction ■ ■ The impact on the energy industry (Enron handled onefifth of the energy transactions in the United States.) The company’s dubious place in business history as the largest... Bank of New York some $2 billion 7 Enron invested in numerous global businesses that eventually triggered the use of off-balance sheet partnerships, largely to hide their mediocre performance and avoid damage to the company Among the worst of these investments were Wessex Water (England) and the Dabhol power plant (India) TE AM FL Y 1 Team-Fly® 12 THE REAL WORLD OF FINANCE Lesson Enron Outcome 8 The. .. revenues 10 THE REAL WORLD OF FINANCE THE ENRON DISASTER Probably no situation in recent years illustrates more finance lessons than the Enron Corporation Much of the story remains to be revealed in congressional hearings, court proceedings, and administrative reviews However, we do know that the finance function became a key element in their business strategy, focusing on the trading of energy and... developed their own e-commerce activities to retain loyal customers 8 THE REAL WORLD OF FINANCE A Dot.Com Success There have been a few near successes in terms of control of a specific market, satisfactory service, and customer loyalty, with the most notable being Amazon.com However, even with nearly 20 million customers, the company has yet to make a profit, and it reported a loss of $1.4 billion in the. .. economy from the perspectives of the working CFO rather than the textbook CFO Why the new economy? And what’s wrong with the old economy? The old economy has been driven by industrial production, resulting in systems of manufacturing and mass marketing The CFO’s job in the old economy was relatively simple, because of certain consistencies in the way business has been conducted: ■ A continuation of similar... coincided with the beginning of the dot.com selloff 6 U.S deregulation resulted from the Telecommunications Act of 1996, Public Law 104–104, allowing new market entrants to offer local, long distance, and global telephone service 7 Stephanie N Mehta, “Why Telecom Crashed,” Fortune Magazine, November 27, 2000, pp 125–129, at 127 14 THE REAL WORLD OF FINANCE 8 For one set of predictions on the industry’s... profitable results An early step in our consulting engagements is to ask the Peter Drucker questions: Who is your customer? Why does he or she buy?5 Companies may be able to answer that question in theory, yet our analysis of sales efforts shows wide deviation from stated business objectives The smartest 26 THE REAL WORLD OF FINANCE marketing organizations in the world have developed the data and the. .. Not one of these axioms is true although they all certainly sound logical This book discusses the mythology of each of these financial “truths” and reviews current practices based on consulting experiences with close to 50 percent of the companies in the Fortune 500 WHY GETTING IT RIGHT MATTERS Why does it matter if these financial truths aren’t completely valid? After all, the disciplines of business . The Real World of finance TEAMFLY Team-Fly ® The Real World of finance 12 Lessons for the 21st Century JAMES SAGNER John. and the role of the rating agencies. This book discusses these challenges in the context of the twenty-first century “new” economy from the perspectives of