Friday 7 April, 2006
The interplay between the role of the boards of companies
(or other organisations) and the financial performance of these
organisations is critical for the success or otherwise of these
enterprises and their management.
It is also fundamental to understand how to use financial analysis in
relationship to boards’ needs to govern the business successfully. This
use of financial analysis must be seen in the broader context of
corporate governance.
Corporate governance has become very high profile over the past few years as corporate collapses have prompted investigation and research into the area of corporate governance.
For example, in the UK the Cadbury Report was issued on the Financial Aspects of Corporate Governance in 1993, in France the Vienot Report, in Germany the 1995 OECD Report, in Hong Kong the Stock Exchange’s “Guidelines for Directors”.
These reports recommended voluntary procedures and behaviours of boards to improve shareholders’ understanding of the control over the company’s finances. Among the recommendations, from the Cadbury Report, included the use of independent non-executive directors and the splitting of the chairman and the chief executive roles.
The London Stock Exchange is moving to make two of the recommendations mandatory on listed companies - that the auditors certify that the company is a going concern and the directors certify that their internal controls are adequate.
In the USA the boards have taken a more active role in assessing the financial performance of the companies under the management control of the senior line management and these boards are removing senior executive based on their financial performance including companies such as General Motors, Kodak, American Express and Westinghouse.
One area, which finds board under pressure to perform, is in the area of creating shareholder value as a central business and strategic financial objective. This has many boards focussed on shareholder value. In the USA where shareholder value concepts have been well accepted it is well documented as to the success of listed companies, which have adopted shareholder value in terms of their stock market performance.
These concepts and analysis have been carried out by the USA consultancy Stern Stewart, which shows companies adopting shareholder value as raising their share price three times the rate of the market, with some companies such as Coca-Cola and Briggs and Stratton quadrupling their value over 5 years, with others such as New Zealand’s Fletcher Challenge and Quaker Oats in the USA doubling their share market value under the shareholder value financial system.
Good corporate governance suggest that organisational financial health depends on having a thoughtful and committed board of directors, at the heart of the company rather than just good managers.
The board strikes a balance between internal and external pressures to ensure the company’s financial survival.
The board must give clear direction and create the appropriate emotional climate, which aligns the people to the intended direction, which will create the desired performance of the organisation.
The board must ensure sufficient people are aligned and committed to a common purpose, with similar values and behaviours to ensure that their organisations can function effectively, efficiently and in a sufficiently profitable fashion.
Each board member is personally responsible and liable financially for their duties and tasks of the board. Directing is a strongly intellectual activity, which should result in boards showing the way ahead and giving leadership.
Boards require a range of thinking and analytical skills and a great deal of support from their professional advisers.
Examples of lack of proper financial analysis to support strategies include the sometimes obsession with organisation’s rationalising which may eventually kill off the organisation. These management fads can be dangerous and require financial and strategic analysis to support the strategies. The directors must put these strategies into their broader strategic perspective and work out the impact on the financial performance.
Management's task is to break down the strategies into operational tasks to form the operational plan of the organisation and then to implement these.
The directors should create political, strategic, emotional environments to allow performance. The board is then the centre of organisation or its business brain and should be monitoring the results, both external and internal learning processes.
The four areas are:
The Chairman needs to promote induction, inclusion, and training to improve the competence of its directors. They should also encourage discriminating questioning by the board of management and strategy, which needs strength and critical questioning, which is based on relevant financial and other analysis to support the questions and solutions to problems or issues arising.
The non-executive board
The non-executive board wholly comprises of non-executive directors deciding policy and strategy, which is then implemented by a chief executive, who acts as the link to the business. This link gives the chief executive much power over the board and controls the flow of information to the board members.
The executive board
Here the executives are also the board members. This tends to be inward looking and the members are similar, so a lack of wide views and external view points are represented.
Two tiered or senate board
This essentially splits into a supervisory (or Senate) board and an operational board. The senate board directs strategy and receives performance information from the operations board, which is charged with running the business. These types of boards tend to become political and rivalry develops between the two boards.
The unitary board
The unitary board has executive directors led by the chief executive director, who are responsible for running the operations of the business, with non-executive directors ensuring accountability and independence in policy and strategy formulation and adding fresh input to board discussion and development. This type of board structure has the best potential for learning and self-correcting.
The role of boards and the use of financial analysis and cashflow techniques are critically interlinked.
Boards need to direct their businesses in strategies, which have been assessed through financial analysis techniques to ensure that the direction will result in appropriate financial results if successful.
The boards also need to monitor performance, are accountable to shareholders, engage in strategic thinking and develop corporate policy all of which demands a wide range of financial analysis techniques and skills to assist the boards in drawing the conclusions they need to make decisions and to contemplate the possible courses of action which they face and develop an understanding of the dynamics of their organisations.
This need for financial analysis support is the reason for so many simple platforms such as the one page analysis format.
This standard analysis format is used by many directors of companies, their senior management and advisers to business to see results and factors, to carry out what if's, to construct sensitivity matrices, to forecast results and generally to see the dynamics of their profit and loss, balance sheets, returns and cashflow.
Source:ceo-online.com
Corporate governance has become very high profile over the past few years as corporate collapses have prompted investigation and research into the area of corporate governance.
For example, in the UK the Cadbury Report was issued on the Financial Aspects of Corporate Governance in 1993, in France the Vienot Report, in Germany the 1995 OECD Report, in Hong Kong the Stock Exchange’s “Guidelines for Directors”.
These reports recommended voluntary procedures and behaviours of boards to improve shareholders’ understanding of the control over the company’s finances. Among the recommendations, from the Cadbury Report, included the use of independent non-executive directors and the splitting of the chairman and the chief executive roles.
The London Stock Exchange is moving to make two of the recommendations mandatory on listed companies - that the auditors certify that the company is a going concern and the directors certify that their internal controls are adequate.
In the USA the boards have taken a more active role in assessing the financial performance of the companies under the management control of the senior line management and these boards are removing senior executive based on their financial performance including companies such as General Motors, Kodak, American Express and Westinghouse.
One area, which finds board under pressure to perform, is in the area of creating shareholder value as a central business and strategic financial objective. This has many boards focussed on shareholder value. In the USA where shareholder value concepts have been well accepted it is well documented as to the success of listed companies, which have adopted shareholder value in terms of their stock market performance.
These concepts and analysis have been carried out by the USA consultancy Stern Stewart, which shows companies adopting shareholder value as raising their share price three times the rate of the market, with some companies such as Coca-Cola and Briggs and Stratton quadrupling their value over 5 years, with others such as New Zealand’s Fletcher Challenge and Quaker Oats in the USA doubling their share market value under the shareholder value financial system.
Organisational financial health depends on its board’s functioning
To understand the interaction of boards with financial analysis you need an appreciation of the board’s roles, challenges and the link between the board’s roles and the supporting financial analysis.Good corporate governance suggest that organisational financial health depends on having a thoughtful and committed board of directors, at the heart of the company rather than just good managers.
The board strikes a balance between internal and external pressures to ensure the company’s financial survival.
The board must give clear direction and create the appropriate emotional climate, which aligns the people to the intended direction, which will create the desired performance of the organisation.
The board must ensure sufficient people are aligned and committed to a common purpose, with similar values and behaviours to ensure that their organisations can function effectively, efficiently and in a sufficiently profitable fashion.
Each board member is personally responsible and liable financially for their duties and tasks of the board. Directing is a strongly intellectual activity, which should result in boards showing the way ahead and giving leadership.
Boards require a range of thinking and analytical skills and a great deal of support from their professional advisers.
Examples of lack of proper financial analysis to support strategies include the sometimes obsession with organisation’s rationalising which may eventually kill off the organisation. These management fads can be dangerous and require financial and strategic analysis to support the strategies. The directors must put these strategies into their broader strategic perspective and work out the impact on the financial performance.
Management's task is to break down the strategies into operational tasks to form the operational plan of the organisation and then to implement these.
Directing is a serious job
The task of directing by board members is a serous job and must be tackled with sufficient resources, proper skills and sufficient back up to ensure the business is properly directed.- Directors must budget time for directing over the year
- The directors provide leadership to ensure the organisation
- Reaches targets
- Learns to self manage
- Achieves budgets
- Hits predetermined milestones
- Create shareholder value
- Reaches targets
Managers v Directors
The distinction between managing and directing is critical to the success of the business. A problem for any organisation is that some directors may slip back into their previous managing roles rather than the directing role and intervene directly in management and even create situations so that they can intervene.The directors should create political, strategic, emotional environments to allow performance. The board is then the centre of organisation or its business brain and should be monitoring the results, both external and internal learning processes.
Four dynamic balances for directors’ focus
The focus of the directors should be in the following main areas, which should be carried out systematically with sufficient time and resources dedicated to the board cycle to ensure the completion of the four main areas of responsibility.The four areas are:
- Organisational effectiveness: External long-term customer’s perception on good value for money
- Organisational efficiency: Internal short-term focus on cost reduction and efficiency gains
- Board performance: External focus on policy formulation to the
external environment, strategic thinking, competitive position, broad
resource allocation
- Board conformance: Internal focus on board’s own performance to pre-set goals of accountability to stakeholders and business performance
Board development process
To ensure that boards develop to meet the requirements of corporate performance a conscious board development process is needed under the Chairman’s eye.The Chairman needs to promote induction, inclusion, and training to improve the competence of its directors. They should also encourage discriminating questioning by the board of management and strategy, which needs strength and critical questioning, which is based on relevant financial and other analysis to support the questions and solutions to problems or issues arising.
There are classic dilemmas facing boards as follows:
- Entrepreneurial and driving business forward, while keeping control
- Must understand the business because answerable for its actions, but stands back to retain objective longer term view
- Sensitive to short term pressures, yet informed on broader trends and competition
- Focused on commercial needs of the business, while acting responsibly to employees, business partners and society
Problem areas for boards
- Directors tend to move back to their comfort zone of managing
- They then supplant the next level of management down who become compliant
- This leads to a blocked development and non-competence at each level
- If direction left to powerful individuals, this may lead to dysfunction of the senior management and board and may also lead to corruption and internal contradictions
Symptoms of corporate collapse in corporate governance terms
The following symptoms of corporate collapse have been identified in the Cadbury and other reports:- One man rule
- A non-participating board
- An unbalanced top team
- A lack of management depth
- A weak financial function
- A combined Chairman and CEO role
Learning Board
It is considered good practice in boards to become learning boards. These are boards learning faster than the competitive environment is changing. To achieve this boards need systems to allow comparisons of the outside environment.- Benchmarking
- Competitor analysis
- Internal responses
- Budgets
- Customer satisfaction
- Financial ratios
- Plans
- Policies
- Productivity
- Projects
- Strategies
- Budgets
Customer satisfaction and “moments of truth”
Customer interacting staff in organisations must behave appropriately toward their customers. The customers have “moments of truth” with the organisation as they interact with the company’s staff or systems. The board should be asking questions, such as:- How many “moments of truth” does the company have each day? How
many are bad? Bad “moments of truth” get amplified to other potential
customers.
- How do the directors find this out?
- Why do customers buy from your organisation?
- Who are the competitors and how well do they do at their “moments of truth”?
Boards do not control the day to day running of the business and need to learn from customers and their own staff who deal with customers
- Boards must listen to staff who interact with customers directly to help the organisation learn from customers
- They need systems to help listen and problem solve for customers
- They must give staff who interact with customers discretion to flex response with customers, to fit customers needs
- Systems and organisation must leads to continuous learning
- Boards need to put in place development systems on own people
Emotional climate and performance
- The board establishes the emotional climate which determines whether or not it is acceptable to learn within the environment
- Must lead by example and be consistent
- Must be prepared to listen to the knowledge within the staff ranks.
This can avoid making the same mistakes (or bigger ones in the future)
- If learning from mistakes is not acceptable they will be covered up instead of being analysed to help the organisation learn
- The board needs to be at the centre of the organisation, as the heart and brain
The learning organisation
The learning organisation required the following conditions:- Regular time is set aside to learn by each person in the organisation
- Systems measure, reward and move the learning towards its targets. People must be recognised for their learning
- Encouragement should be given to continuously develop the organisation through internal and external learning
- Learning must be valued in the performance systems and seen as an asset of the organisation
The difference between the board and the management
The basic difference between the board and the executive management is in the areas of focus. The board tends to focus on policy and strategy and the executives to carrying these out and on the tactics and operations of the business.Board types
The following are the are four main types of board:The non-executive board
The non-executive board wholly comprises of non-executive directors deciding policy and strategy, which is then implemented by a chief executive, who acts as the link to the business. This link gives the chief executive much power over the board and controls the flow of information to the board members.
The executive board
Here the executives are also the board members. This tends to be inward looking and the members are similar, so a lack of wide views and external view points are represented.
Two tiered or senate board
This essentially splits into a supervisory (or Senate) board and an operational board. The senate board directs strategy and receives performance information from the operations board, which is charged with running the business. These types of boards tend to become political and rivalry develops between the two boards.
The unitary board
The unitary board has executive directors led by the chief executive director, who are responsible for running the operations of the business, with non-executive directors ensuring accountability and independence in policy and strategy formulation and adding fresh input to board discussion and development. This type of board structure has the best potential for learning and self-correcting.
Board’s roles
The roles of the board have been outlined by Bob Tricker, Corporate Governance (London, Gower press, 1980). These roles were:- Accountability
- Supervision
- Strategic thinking
- Corporate policy formulation
| Roles of the Board | Details of Role | Cycle of Board Year | Focus |
|---|---|---|---|
| Accountability |
|
Governance review | External & short term |
| Supervision |
|
Operations review | Internal & short term |
| Strategic thinking |
|
Strategy review | Internal & long term |
| Corporate policy formation |
|
Strategy review | External & long term |
Conclusion
The role of boards and the use of financial analysis and cashflow techniques are critically interlinked.
Boards need to direct their businesses in strategies, which have been assessed through financial analysis techniques to ensure that the direction will result in appropriate financial results if successful.
The boards also need to monitor performance, are accountable to shareholders, engage in strategic thinking and develop corporate policy all of which demands a wide range of financial analysis techniques and skills to assist the boards in drawing the conclusions they need to make decisions and to contemplate the possible courses of action which they face and develop an understanding of the dynamics of their organisations.
This need for financial analysis support is the reason for so many simple platforms such as the one page analysis format.
This standard analysis format is used by many directors of companies, their senior management and advisers to business to see results and factors, to carry out what if's, to construct sensitivity matrices, to forecast results and generally to see the dynamics of their profit and loss, balance sheets, returns and cashflow.
Source:ceo-online.com
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