Getting Strategic with Cash: How to Craft the Capital-Allocation Plan

It wasn’t so long ago—think pre-2008—that when it came to managing cash, “strategic” was a tainted word for many CFOs. Why? Because in the context of cash management, being strategic sometimes meant “little or no return on your investment.”

But the low-growth macroeconomic environment of the last 10 years means CFOs might have to get outside their comfort zone when it comes to using cash strategically to drive growth, as well as to deliver expected returns and maintain a strong balance sheet.

Being able to use cash strategically is really where the rubber hits the road for CFOs because they own the capital-allocation process. But it’s critical that they partner with their CEO to make sure the capital-allocation plan is aligned with the enterprise strategy, and that it funds the business investments most likely to achieve the strategy and other objectives disseminated to the investor community.

“Could the investment blow up the financial metrics? If so, could the investment be scaled up incrementally and spread over two or three years, instead of one, and still meet the strategic objectives?”

Of course, CFOs also need to have a strong dialogue with the board to keep them informed on not only how the funds would be spent, but on how the capital-allocation plan overall would help build shareholder value.

As I prepared each year for discussions with the CEO, the board and others about my capital-allocation plan and readied myself for some tough challenges, I kept several questions at the forefront of my mind.

Is the plan solid from a shareholder’s perspective?

Cash is king. How you generate it and use it to generate more cash determines shareholder value.

But there’s no perfect formula for achieving growth and ROI. There’s no perfect play for striking a balance for investments, dividends, stock buybacks, debt reduction or holding it in reserve.

While Wall Street wants companies to maximize their ROI, the Street could punish them for not growing. Is an investment that dilutes ROI by a few percentage points but can ultimately boost shareholder value a poor investment? Of course not.

Neither is keeping enough cash in reserve when a new, strategically important opportunity presents itself. CFOs need the fortitude and strategic discipline to push back against short-term thinking on shareholder value.

Can the organization afford the investments and over what time period, taking into account other factors?

For me as CFO, maintaining a strong credit rating was the foundation of capital allocation. But at the same time, I recognized the importance of investing for strategic reasons.

For capital-allocation decisions that could have a major impact on the balance sheet, there are a host of questions CFOs can ask themselves, but they can be boiled down to a handful:

  • “What are we getting in return for that investment?”
  • “How long will it take to get that return?”
  • “Could the investment blow up the financial metrics?”
  • “If so, could the investment be scaled up incrementally and spread over two or three years, instead of one, and still meet the strategic objectives?”

Does the organization have the capacity to execute the strategy?

Assessing the organization’s ability to execute on what is being proposed for its cash is critical for CFOs as stewards. Generally, CEOs, heads of strategy and business segment leaders are optimistic for their organization’s future growth—as they should be.

But sometimes, their outlooks can be a shade too rosy or their appetites for risk a bit too large. For CFOs to make that call requires in-depth understanding of what the organization can realistically achieve, in terms of talent, resources and other capabilities, against a range of internal and external factors.

My first step in the capital-allocation process was to sit down with members of my finance and strategy teams to discuss what the business segments were seeking. We would ask: “Does it align with the enterprise strategy, is it realistic, and are there any gaps?”

Next, I’d take that evaluation to the CEO and we’d discuss the capital plan in terms of how each proposal fit with the enterprise strategy and whether it could be executed.

CFOs have a number of accountability tools at their disposal to enforce cash management discipline. For example, we tied executive compensation to cash-generation metrics, especially ROI

Does the capital-allocation plan drive accountability?

Throughout the capital allocation planning process, I made sure business segment leaders understood that, by taking capital for their planned investments, they were making a commitment to the CEO and shareholders to achieve their targeted ROI.

We made sure the businesses were using appropriate metrics to measure how they were using their capital, that they were tracking the capital flow regularly, and that they were communicating the results back to finance.

No matter how strong an organization’s governance frameworks and processes, it’s important for CFOs to be aware of the “I want to buy this, and I want to sell that” mentality, and how it can impact accounts receivable and accounts payable and hurt the balance sheet.

CFOs have a number of accountability tools at their disposal to enforce cash management discipline. For example, working with HR and the board’s compensation committee, we tied executive compensation to cash-generation metrics, especially ROI, to drive home the importance of paying attention to how executives’ decisions could impact cash performance—and how they are compensated.

Balancing the Art and the Science

Finally, developing an effective cash strategy is as much an art as a science. Every year of my tenure as CFO brought with it new external and internal dynamics that influenced how I approached decisions on whether to spend more or less on dividends and buybacks, and how to balance investing in growth versus focusing on returns. And every year there were new challenges to implementing those decisions.

The key to being strategic with cash, I believe, is that, along with the assessments and processes that go into capital allocation planning—the “science” so to speak—CFOs sometimes have to be willing to say “yes” to investments in the name of strategic growth. That and their capability to understand when the strategic opportunity outweighs the risk, is where the “art” comes in.

Ultimately, CFOs earn their pay when they help the CEO develop and execute on their organization’s strategic vision to build shareholder value and do so with financial discipline and integrity.

About the Author

Charles Holley, retired CFO of Walmart, serves as an independent senior advisor to Deloitte LLP and as CFO-in-Residence of the CFO Program. For more information about Deloitte’s CFO Program, visit www.deloitte.com/us/cfocenter.

Copyright© 2017 Deloitte Development LLC. All rights reserved.

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