Two Rules in Investing In the HBO video above, Warren Buffett?discusses Graham’s two rules of investing. In addition, you have read about the role of the CFO and how fin

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JWI 531 (1202) Page 1 of 10

JWI 531: Financial Management II

Week One Lecture Notes

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JWI 531 (1202) Page 2 of 10

LET’S MAKE SOME MONEY What It Means Businesses exist to make money. It’s that simple. It doesn’t matter what the industry is, or whether it’s a startup operated out of a garage or a multi-billion-dollar giant. If the company is not making money, then eventually, it will have to shut its doors. To be effective in a senior role in any organization, you must understand how financial results are generated, evaluated, and communicated. The same is true for anyone with aspirations of being a successful long-term investor. Why It Matters

• It is impossible to be a champion for great strategic ideas in your organization if you can’t offer a compelling and realistic picture of the financial results they will produce.

• The evaluation of every important decision your organization makes will include financial analysis.

In order to have a seat at the table when these decisions are being made, you need to understand the financial analysis tools and techniques that will be applied.

• A lack of familiarity with the key principles of finance will, sooner or later, become a career-limiting issue.

“The most important investment you can make is in yourself.”

Warren Buffett

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JWI 531 (1202) Page 3 of 10

INTRODUCTION Welcome to the course. Over the next ten weeks, we will explore a variety of topics in finance with a focus on why business leaders and savvy investors need to understand the role of finance as a strategic tool. It’s hard to think of any important decision made in any organization that doesn’t include some form of financial analysis. Of course, most managers are non-financial managers. They come from areas like marketing, sales, operations, and human resources. When it comes time to make the important decisions within these different functional areas, too often, these non-financial managers depend on someone else to perform the financial analysis and develop the financial strategies needed to support the business. Often, they will just accept the financial information they’ve been provided as inputs to their decision- making without asking any questions. The same can be said about most investors. They either pick stocks based on the latest “hot tip” they hear, or they stay clear of the stock market entirely because of an unfounded fear that it’s either too risky or too confusing. But value investors, like Warren Buffett, have built fortunes by digging into the numbers and understanding what they tell us about the financial health and prospects of potential investments. If you are a non-financial manager who wants to break free of this dependency on others to do your financial analysis, you have come to the right place. This course will build on the foundation that was established in JWI 530. You will see some familiar topics, but you will be pushed to think further about how to leverage the tools of finance to drive strategy. You will deepen your knowledge of:

1. The internal financial planning tools of risk management, forecasting, and capital budgeting. These are the critical areas of financial strategy necessary to guide and support the business decisions you need to make.

2. The financial markets and how results are reported to external parties like shareholders and creditors. You need to understand how your organization is being evaluated by investors, and how the decisions you make will impact valuation.

Our focus in this course is on the creation and preservation of value. This occurs when companies increase revenues, cut costs, and manage risks. We will explore the financial markets through the eyes of one of the most successful investors the world has ever seen – Warren Buffett. We will also look at the operation of our own businesses from the perspective of the CFO. Don’t worry if you don’t aspire to be a CFO. That’s fine. But to understand everything that senior finance professionals do to support the company’s strategy, the best perspective is from the top. While there may be some topics we cover that are not a part of your day-to-day responsibilities in your organization, understanding how and why these financial tools can be applied will be invaluable in making you a better manager. Throughout the course, no matter what the topic is, we will always come back to the question of “how will this make me a better leader in my business?”

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JWI 531 (1202) Page 4 of 10

COURSE OVERVIEW

Week Main Themes

1. Let’s Make Some Money

We begin our course with an exploration of the roles and responsibilities of financial leadership in corporations, examining the partnerships among the CFO, CEO, and business leaders in managing the financial resources needed to drive growth and achieve the organization’s mission.

2. Defending Your Castle

Managing risk to generate above-average returns is the goal of investors and managers. We review the most common risks businesses face and what can be done to mitigate the negative impact if these risk events occur.

3. Measuring What Matters

Financial leaders have an important role to play in quantifying, analyzing, and communicating the key performance indicators that are most important to running the organization and strengthening its competitive advantage.

4. Mergers, Acquisitions, and Valuation

Sound financial guidance is critical in helping CEOs, boards, and business strategists assess the value of potential acquisition targets, quantify synergies and growth opportunities, and work with operators to integrate the organizations post-merger.

5. Forecasting and Planning

Developing a strategic plan without a solid financial foundation is a recipe for disaster. We examine how financial professionals should work with managers and other business leaders to evaluate market opportunities and develop a growth model based on accurate forecasts and management of risks.

6. Strategy and Capital Budgeting

After developing the strategic plan, it’s time to build a capital budget that will allow the plan to be realized. This week, we focus on the alternatives and rationales that CFOs have to consider in making wise budgeting decisions.

7. Is Cash Really King?

Cash flows through organizations in numerous ways that are not always immediately connected to the daily operation of the business. Cash may be held in reserves for deployment when new opportunities arise or as a safety net for economic downturns. We examine ways to put cash to work and minimize the inefficiencies of poor cash management practices.

8. Show Me the Money

When companies need to raise funds for new initiatives, they typically have two choices – borrow it or exchange partial ownership (equity) for it. Each has advantages and disadvantages. This week, we explore debt and equity financing and how each can impact the valuation of the organization.

9. Welcome to Wall Street

Understanding the role of capital markets in raising funds for the operation and growth of the business is critical to sound financial leadership. We discuss the pros and cons of going public, and why developing your market knowledge can make you both a better investor and a better steward of your company’s finances.

10. Investor Relations

We draw the course to a close by discussing the roles and responsibilities of the CEO and CFO in the accurate communication of the financial health of the organization. We also explore how shareholder engagement can help build a more competitive organization.

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JWI 531 (1202) Page 5 of 10

LECTURE NOTES FOR THIS COURSE

The purpose of the lecture notes in this course is NOT to reteach topics that are covered in the textbooks, readings, and videos. Their purpose is to:

1. Help you assess your starting point by providing a realistic picture of the challenges you may face, but also the payoff that comes from mastering the skills.

2. Focus your work on the most important themes and takeaways from each week’s materials.

3. Provide tips on applying what you are learning in your own workplace to help you become a more effective business leader.

You are encouraged to read the lecture notes first each week, and then to reread them after you have completed your other coursework in order to reinforce what you have covered. The core text for this course, The CFO Guidebook by Steven Bragg, contains a lot of information. Some of this will have an immediate application in your current role, while other parts will serve as more of a reference guide that, we hope, you will return to for years to come. You are encouraged to read the text and the supporting readings carefully each week. These will not only cover the core content you need to know about finance from the perspective of a senior leader, but will also help you learn to think like a CFO. This will help you ask better questions, push and probe and challenge assumptions, and, ultimately, make better strategic decisions.

THE CHALLENGE AND OPPORTUNITY FOR MANAGERS

In each set of lecture notes, we will include a section like this with “The Challenge and Opportunity for Managers.” This will introduce the financial topics addressed in that week, present some barriers that managers face concerning finance, and explain how the tools and practices we cover can help you become a better leader. Learning finance strategy can seem intimidating. It’s strewn with jargon and seemingly impenetrable terminology. It’s easy to let all those technical terms become a barrier to your education. However, if you take the time to engage the course materials, you’ll find that what you learn is a lot easier to apply than you might have believed. In fact, with a little effort, that barrier may just crumble completely. And the good news is that what you have already learned in JWI 530 will set you up for success in this course. As Jack has often said, one of the most important actions that effective leaders take to drive results is to ask probing questions that uncover (often hidden) assumptions. These questions can be starting points to help you assess your own strengths and opportunities as well as the level of knowledge you bring to this course.

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JWI 531 (1202) Page 6 of 10

YOUR STARTING POINT

1. How comfortable are you in reading your organization’s Income Statement? Are you familiar with your organization’s policies that shape revenue and expense recognition?

2. How comfortable are you in reading your organization’s Balance Sheet? Are you familiar with

your organization’s policies that shape the valuation of assets and liabilities?

3. How comfortable are you in reading your organization’s Statement of Cash Flows? Are you

familiar with how cash transactions might be categorized into one of the three types of cash flows shown in that report?

4. Think about a product or service that your organization sells and with which you’re involved.

How closely have you analyzed the cost of producing that good or service? Can you disaggregate the cost into the components that support decision-making?

5. Think about the operational budgeting process in your organization. How do you compare

budgeted results with actual results to understand why there are any differences? Is your comparative analysis as helpful as you want it to be?

6. If you’ve identified an opportunity for a strategic investment by your organization, how did you

present and support a proposal? Are you comfortable with the capital budgeting tools of Net Present Value (NPV), Internal Rate of Return (IRR), and Payback?

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JWI 531 (1202) Page 7 of 10

FINANCIAL LEADERSHIP AND STRATEGIC PLANNING

The Key Players As we begin our course, we will explore the roles that CFOs and other financial leaders play in strategic planning. Bragg presents an insightful synopsis of what it takes to be an effective CFO:

“The CFO must have a strong knowledge of accounting issues, cash flows, investor relations, tax planning, and financial reporting. This knowledge should be coupled with the ability to communicate easily with the entire senior management team and the board of directors, as well as bankers and auditors. Thus, the ideal CFO is one with the process orientation of an engineer, the knowledge base of a librarian, and the persuasion skills of a preacher.”

The CFO Guidebook, p. 1 That’s a pretty tall order that includes a lot of responsibility. In order to be effective in this complex role, CFOs must assemble a team of skilled financial professionals under them. Bragg presents a chart on page 7 that outlines the typical reporting structure of the senior finance leaders in most organizations. As you review this, take note of the other critical finance position – the controller.

“The controller manages all of the accounting operations within a business, which can safely be considered the single largest responsibility of the CFO.”

The CFO Guidebook, p. 3

“The controller is responsible for the detailed daily operations of the accounting department, as well as for creating the financial statements and other reports. The CFO has a much broader and higher-level role, being responsible for planning, finances, risk management, and the management of a number of areas besides the accounting department.”

The CFO Guidebook, p. 5 A Quick Recap You’ll recall from JWI 530, there are two primary divisions in finance – financial accounting and management accounting. Financial accounting is focused on the creation and preparation of financial reports for people or parties outside the organization. These reports include familiar financial statements, such as the Balance Sheet, Income Statement, and Statement of Cash Flows. Referring to the targeted users of these reports as “external” is meant to differentiate this group from “internal” users and managers. These financial reports are prepared by the senior financial leadership team to describe the financial results of the organization to parties not involved in daily operations and decision-making processes. While the list of external users can include a number of parties, it is the owners, or shareholders, of the organization who top that list. Given that management is the steward of the owners’ wealth, one of the CFO’s primary roles is to report to the owners regarding the organization’s financial results for a specific period and at a specific moment in time.

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JWI 531 (1202) Page 8 of 10

We will also examine the role of the CFO in developing and communicating finance strategy for internal users of financial information. This includes the set of tools and techniques used by management to inform and support managerial decision-making. Topics within the field of management accounting include costing, operational budgeting, and capital budgeting. This short list highlights analyses regularly conducted by organizations, but rarely published or shared with parties outside of the organization. Beyond the two groups of intended users of the information described above, it is also helpful to separate the responsibilities of the CFO in two additional ways – those that concern the past, and those that concern the future.

• Financial accounting statements describe the past, whether that is a past period, like an Income Statement or Statement of Cash Flows, or a point of time in the past, like a Balance Sheet. The CFO, along with the Controller, are responsible for ensuring that all financial accounting is done according to strict guidelines and presented in a standard set of reports. This highly structured process is necessary because the users of financial statements want these reports prepared using established principles in a verifiable, auditable manner.

• In contrast, financial strategy is about the future, and is focused on forecasts of what goods and services will cost to produce, what operating costs and revenues will look like, and how future cash flows associated with a capital investment will unfold. Management accounting, thanks to its focus on decision-making and its internal use, has very little in the way of structure. Instead, management accounting may be best considered a toolbox of techniques.

Finance and Strategy Throughout the course, we will explore the multi-faceted impact of financial leadership and financial strategy. To get us started, strategy can be summarized into three steps (pp. 12-13):

1. Defining the strategic goal 2. Documenting the current capabilities of the company 3. Developing a plan to reach the goal, starting with the company’s current capabilities

As part of this whole process, the CFO will be a key partner and driver of several critical strategic components. These are introduced in Chapter 2 (pp. 12-21) and will be explored in greater detailer later in the book. Namely:

• Selecting a type of strategy • Risk analysis • Maintaining a tight strategic focus • Optimizing the pace of growth • Developing an acquisition strategy • Guiding decisions about outsourcing • Cash Management

We trust you will enjoy digging into all of this. So, let’s see how companies actually make money!

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JWI 531 (1202) Page 9 of 10

SUCCEEDING BEYOND THE COURSE As you read the materials and participate in class activities, stay focused on the key learning outcomes for each week and think about how they can be applied to your job. These are presented at the top of the weekly course pages in Blackboard and in the Course Guide, and are also summarized in this section of the lecture notes.

• Discuss the role financial management plays in the strategic development of the organization As Jack says, “Dig in and start asking questions.” Whether you currently have financial management responsibilities in your job or not, you should make a conscious effort to apply a financial lens to everything you and your team do. If there is a new process or strategy being discussed, ask questions about what it will cost and how it will generate a return for the organization. If there are current practices being reviewed, step back and consider the financial implications. Don’t worry if you can’t immediately get all the answers you’d like. The point is to start to shift your thinking so that the financial implications are front and center.

• Examine the role of the chief financial officer and other financial leadership and governance roles If you work closely with financial managers in your organization (and if you don’t, go and introduce yourself), explain that you are taking this course and are focused on improving your financial skills. Ask if they would be willing to be a sounding board from time to time, or even if they could provide a little coaching. That way, if you do come across topics that are particularly challenging or intriguing, you can discuss these with your colleagues who are financial managers. Depending on the size of your organization, you may even be able to connect with the CFO. This also gives you a great opportunity to network and lift the veil on how finance strategy works in your organization.

• Learn key financial terms and concepts Don’t allow yourself to get overwhelmed by the terminology. Stay focused each week on the key concepts and language that get introduced. If something is presented that you are struggling with, try doing a web search for that term and see how it’s treated in other sources. Sometimes, seeing the way different people explain the same topic can help it “click.”

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JWI 531 (1202) Page 10 of 10

ACTION PLAN To apply what I have learned this week in my course to my job, I will…

Action Item(s) Resources and Tools Needed (from this course and in my workplace) Timeline and Milestones Success Metrics