Much has been written about the need for companies to focus on cost optimization activities and working capital improvements since the contraction of the global markets in 2008 and early 2009. Despite this, new data shows that companies globally have allowed the difficulties in the market to negatively affect their working capital performance.
As the global economy improves, many leading companies will use this time to fuel growth and will likely need additional capital. With revenue preservation and expense management having been placed under scrutiny in the last 12 to 18 months and external capital markets still in early recovery, capital will need to be pulled from other areas for those companies looking to generate internal capital.
As financial and operations executives seek to refocus on working capital, performing a balance sheet review may uncover additional areas to finance growth as the global economy improves.
Questions to Ask
A balance sheet review is a broad, tactical effort to improve the visibility into the balance sheet assets and liabilities. Once inventoried, a strategic view can be taken to identify and implement cash generation and preservation opportunities.
The balance sheet review team needs to have broad experiences in areas such as finance, treasury, supply chain, real estate, insurance and business process improvement. While the ultimate goal is to free up cash, it can also be used as a check to gain visibility into how the corporate strategy is being executed.
Executives and board committees may have asked similar questions:
- Do we have a holistic view of all the office space we own versus lease? Is it being utilized effectively?
- Is our nightly cash sweeping strategy being implemented in every line of business consistently?
- How should liquidity be managed in our organization, locally or centrally?
- We operate a supply warehouse. Do we even need this resource or should we push back on our suppliers to provide us an on-demand shipping solution?
- Can we monetize our parking deck?
- Am I getting the value out of the IT assets I purchased last year?
These questions, while encompassing many broad domains, speak to a lack visibility into balance sheet assets and liabilities. A balance sheet review will highlight the specific areas, be it treasury, cash management, inventory management, real estate or technology, where more detailed work is needed. The outcome of the balance sheet review, therefore, is a list of opportunities to be executed in the near- and long-term.
Balance Sheet Review
The balance sheet review is more than just a working capital exercise. While working capital focuses primarily on the revenue, inventory and payables areas, a balance sheet review is grounded in an effort to review every in-scope asset and liability account. Because of the broad nature of a balance sheet review, a working capital improvement program may be an opportunity that is highlighted as a result.
Depending on the state of the finance and treasury functions in an organization, a balance sheet review can serve as an excellent kick-off point for a new CFO. This will allow the new CFO to get an accurate picture of how the finance organization is performing and how they are supporting their stakeholders. For example by reviewing the cash accounts, the CFO will have a confirmed understanding of how the organizations cash management policies and processes have been implemented (consistently or not).
The balance sheet review is also critical for organizations that have grown through acquisition and are seeking to understand what additional synergies can be gained from items that may have been inadvertently overlooked during the initial merger and acquisition effort.
For example, a balance sheet review of one company revealed that a division owned a small but valuable plot of land. This real estate had been purchased during the time of a prior owner. Because most of the finance and accounting staff were new to the organization, the plot of land had been overlooked during the acquisition. Only after the team inquired about the current balance of a real estate account was it discovered that this was an asset that did not fit into the new corporate strategy and could be monetized.
A balance sheet review is typically done in two phases: 1) an initial phase that consists of a rapid diagnostic and assessment of opportunities, and 2) a deep analysis phase where the initial opportunities are further scrutinized and detailed action plans are developed.
The initial phase consists of a team of experienced advisors who need to be well versed in broad aspects of the company’s domains. It is for this reason that many firms choose to outsource this type of project to a trusted advisory. While almost all companies have this knowledge in-house within the various functions, it seldom exists in a few individuals who are not also already tasked with executive leadership roles and who are running the company.
In addition to a documentation review (consisting of items like the balance sheet, income statement, statement of cash flows, trial balance, chart of accounts, tax returns, actuarial reports, bond statements, etc.), the team will need to spend some time with the senior business leaders and managers as they investigate each in-scope asset and liability account.
This task is markedly different than the review that your auditor is performing. Primarily the auditor is performing their review with the perspective of financial statement assertions: completeness, accuracy, valuation, etc. The balance sheet review team is asking a different set of questions: Can this asset be monetized? Does this asset fit within the current corporate strategy? Can we improve a process to reduce this liability?
In addition to the preliminary list of recommended balance sheet improvement areas, the team should guide the executive team with a framework for deciding which opportunities move to the next phase. Not every opportunity will be equal. Factors to consider include: implementation risk, level of difficulty, financial impact, fit to strategy, and of course effort and duration. Once the measurement objectives and criteria are defined, they are used to narrow the list of opportunities entering the next phase.
The deep analysis phase serves as the work effort to develop the business case to move forward. The idiom “you sometimes have to spend money to make money” applies. For each project in the deep analysis phase, two deliverables are developed: a business case, including information on project description, team organization and final scope, and a project plan, to include detailed steps to reach business case benefits. From here, a normal portfolio and program management governance process applies.
As the global economy continues to recover, firms will naturally move out of value preservation mode and back into value creation mode. Having the necessary capital will be a key component necessary to meet growth plans. With a still-weakened capital markets, firms may find a strong need to look internally for capital generation. While the traditional approach of a working capital improvement project still applies, a balance sheet review can uncover additional areas of capital generation that would be missed by traditional working capital-based approaches.
About the Author
Jonathan Collins writes the blog CFO Newsletter, where this article first appeared. He is a senior manager for KPMG China in Hong Kong. Combining a passion for finance and accounting, an enthusiasm for business improvement and deep experience in technology, Jonathan specializes in turnaround and improvement efforts for CFOs and CIOs. He can be reached at [email protected].