A Chief Financial Officer should be in charge of ensuring optimal profit margins in the long term, driving strategic transformation that has significant effects on the company’s bottom line.
Although often regarded as somewhat of a “controller” whose main job is to ensure compliance in the financial division, a CFO can – and should – actively question company operations and drive meaningful change to achieve higher profit margins, and boost the business’ value.
Founders and external investors alike are increasingly focused on profitability. Therefore, the CFO of today is required to have such a deep understanding of their company that allows them to identify which business units are delivering returns.
This is often obtained by profit mapping, which is the first step for CFOs to lead initiatives with the aim of ensuring that 100% of the business is profit-oriented.
The CFO’s job is not complete unless they set up systems to consistently measure the business’ performance based on profit metrics. These systems ensure that potential threats to profit are identified with precision and timeliness.
At least 30 percent of each company’s business by any measure (accounts, products, transactions) is unprofitable, but that this is offset by a few islands of high profitability.
Jonathan Byrnes, Senior Lecturer at MIT
Although this statement may seem exaggerated, it is surprisingly accurate.
Of course, this column from Byrnes dates back to 2006. Companies – especially private ones – have gotten better at being profitable over the last 15 years, but the rationale behind it is nonetheless very relevant.
Byrnes argues that a combination of factors often leads business leaders to keep running business divisions in an unprofitable way, including:
- Lack of consistent targets across business functions;
- Lack of a holistic approach to profit structure;
- Lack of accountability for profitability management.
A good CFO can address all three of these factors, starting by mapping profit.
Byrnes defines a profit map as “a clustering of customers, products, services, and transactions by profitability, and an analysis of the key profit drivers.”
Through profit mapping, a CFO can identify which operations are profit-generating and which ones are running at a loss. From there, strategic changes can be made to make sure that 100% of the business is optimised for profit.
For example, sales teams are often trained and rewarded on the basis of the revenue they generate, but not all revenue is made equal. In this case, optimising for profit could actually mean training sales staff to focus on high-margin sales rather than maximising revenues.
According to Byrnes, the CFO can act as a “Chief Profitability Officer”, building the profit map into the business model, integrating profit margin optimisation into all operations. By working closely with the sales and marketing teams, the CFO should help define key market segments and accounts on the basis of profitability.
Driving Strategic Transformation
The importance of financial leadership taking on a central role in business transformation has been argued for the past two decades at least. McKinsey Partners Ryan Davies and Douglas Huey write:
“Without the CFO’s leadership certain key elements of the transformation are likely to receive short shrift: performance efforts will lack a meaningful benchmark to gauge success, managers will be tempted to focus on the biggest or most visible projects instead of those that promise the highest value, and expected transformation benefits won’t make it to the bottom line.”
Although the idea of business transformation may be associated with large established corporations trying to stay ahead of the curve, the same concept applies to young business growing fast and potentially pivoting to exploit unforeseen opportunities.
Many ambitious start-ups are led by a “move fast, break things” philosophy. Sometimes the management team is reluctant to let the finance function lead transformation because they think that careful, data-driven decision making might slow down their disruptive growth.
In a lot of cases, however, the CFO can fully get behind this philosophy, it is only the case that they know where is best to move, and which things to break.
Thanks to their understanding of the marginal economics of the business, as well as their ability to identify value creation, CFOs are best placed to assess whether initiatives are set to boost profitability significantly without impacting long-term growth.
Establishing Smart Performance Measurement
One of the ways a CFO adds the most value to a business is by implementing a performance measurement system that – on its own – is capable of pinpointing key profit drivers and gives the management team actionable insights to maximise profitability.
Thinking creatively beyond the Profit & Loss statement, CFOs often implement internal reporting standards that ensure that the right metrics are being measured.
That doesn’t mean that department heads shouldn’t be free of establishing their own performance measurement systems. Quite the opposite, in fact, as when CFO works along the department heads to identify the performance metrics that have the most impact on profitability, the best results can be obtained.