Project Evaluation: In large corporations senior management often receives requests from operating units or divisions for investment often called venture capital. Financial analysts in the capital budgeting and investment analysis area must analyze these proposals, determine their value, and provide recommendations to senior management about them. The proposals vary in format, but usually contain the information necessary for a complete financial analysis. Sometimes a completed financial analysis is included, and only an evaluation is needed.
A financial analysis usually involves the following: project classification, estimation of cash flow and sensitivity analysis, project evaluation and ranking, and post-completion audit. Project classification facilitates management's review. A project classified as an expansion usually involves more detailed analysis than one classified as a replacement project, and a high-cost project usually requires a detailed analysis regardless of category.
Once you have classified a project, various paths may be taken to complete the analysis, depending on the project's category. Usually, for simple replacement or cost reduction projects, a cost/benefit analysis will suffice. Larger investments or expansion projects require a detailed cash-flow analysis that goes beyond most cost/benefit analyses. You may have to travel to operating units or installations to obtain the necessary information.
The most important and most difficult step in analyzing a project is calculating cash flow. Numerous factors are involved in forecasting project cash flow and many hours are spent developing spread sheets. It is often necessary to repeat calculations with small changes to evaluate "what if" alternative outcomes. This is called a sensitivity analysis; it is done to determine the changes in expected cash flow given changes in forecasts.
Several projects are typically reviewed each quarter, and it would be your responsibility to rank them according to financial merit. There are several methods used to rank projects, including net present value, project payback, average return on book, internal rate of return, and profitability index. These methods are used frequently in business today. You should be familiar with them, aware of the limitations of each technique, and able to apply multiple methods of analysis to ensure accurate project evaluation. Once the projects have been evaluated, they are ranked according to both financial and operating criteria. Middle or senior management generally performs this ranking, while the financial analyst consults and recommends.
After projects have been approved and carried out, the analyst completes the final aspect in the capital budgeting procedure-the post-completion audit. This audit involves a comparison between actual project results with those predicted, and an explanation of the differences. This audit of new projects is often assigned to the controller (whose responsibilities are described below).
The capital budgeting function of a financial analyst is rarely routine, due to the various projects being considered and evaluated. This position also offers the opportunity for wide exposure to the company's operations. The entry-level analyst often spends a significant amount of time making calculations, developing spread sheets, doing sensitivity analyses, and gathering information for senior-level analyst decision making. Since it may take two or more years to become a senior analyst, the early years can be frustrating for those wanting to make decisions. However, senior analysts generally feel that the tasks performed initially form a necessary developmental process for the positions of authority attained later. Positions of higher authority, such as vice president of finance, treasurer, and assistant treasurer, usually decide the fate of projects as well as arrange financing for their implementation.
Project Financing: Projects can be financed by cash and marketable securities reserves, long-term debt (bond) issues, equity issues, or long-term debt from commercial banks. The decision regarding which source to use is a difficult one, and corporate financial managers seldom have sufficiently broad knowledge of the existing financial market to choose the most effective method of project financing. A common practice is to consult with a corporate finance expert in a commercial or investment bank. Such financial institutions have considerable expertise in corporate capital structure formulation.
FINANCIAL PLANNING STRATEGY
As we have noted, the capital budgeting and investment analysis group is involved in the evaluation of capital venture proposals and the securing of funds to support recommended projects. Another group in the treasury department, responsible for financial planning and strategy, links these activities to the corporation as a whole, taking into consideration the combined effect of investment and financing decisions. This includes financial planning and possible mergers and acquisitions.
Financial planning: The planning function is usually divided into the following four responsibilities:
- analyzing the financing and investment choices open to the firm
- projecting consequences of present decisions in order to avoid surprises and to understand the linkages between present and future decisions
- deciding which alternatives to undertake
- measuring subsequent performance against the goals of the financial plan
This planning process usually begins with the financial planner obtaining data for the operating units a business plan, often in the form of a five-year outlook. Each plan may be structured with several scenarios, one perhaps built around aggressive growth, another around normal growth, and another around retrenchment or divestiture. If not already done at the operating unit level, the calculation of cash flow for each alternative is computed by the financial planner. With the cash flow analysis at hand, the financial planner then examines the alternatives as mutually exclusive capital projects. They become the basis for a consolidated corporate financial and strategic plan.
The second major function of the financial planner is to project the consequences of decisions. This involves forecasting the effects of the economy and industry competition on the company's earnings. Since some companies do not have the information resources and technical expertise to do accurate forecasts, they may hire firms which specialize in preparing macroeconomic and industry forecasts.
Once a company has its "best" forecast, the financial planner has accumulated enough information for senior management to decide which of the alternatives to undertake. As in capital budgeting, your role as financial planner at this stage would be to gather information, perform calculations, and recommend possible alternatives-the third function in this process. Sometimes, however, recommending an alternative is reserved for middle management.
The final function of the financial planner is to compare actual financial performance to the stated goals in the financial plan. However, this may also be the responsibility of the controller's office and is therefore discussed below.
For a financial planner written communication skills are essential. It would be your responsibility as financial planner not only to develop pro forma financial statements consisting of "best estimates" of earnings, but to describe and explain planned capital expenditures. In addition, a clear description of the business strategies and financing planned to achieve these goals is necessary. Hence, the results of your numerical and analytic skills must be translated into concise, persuasive statements of desired courses of action.
Financial planning positions offer an opportunity to be exposed to all of a corporation's financial functions. They also involve two aspects which can be particularly advantageous for your career. First, you would interact regularly with higher level managers. Second, you would be exposed to the major financial functions and decisions of the firm. This facilitates mobility as a financial manager both within and between organizations.
Your hours as a financial planner tend to be longer than those for other entry-level financial positions, due to the necessity of meeting report deadlines. The manager of entry-level financial planning personnel is often the vice president of finance or the treasurer. When this is the case, entry-level people also serve as "assistants" to this senior staff member; this work may involve substantial "busy work." Performing both financial planning and assistant functions may increase your work load to as much as 50-55 hours per week. However, this will depend on the attitude of your superior toward you and the financial planning function.
Mergers and Acquisitions: Mergers and acquisitions involve both investment and financing decisions and therefore are included under financial planning strategy. Mergers and acquisitions are not regular events; there is seldom a separate M&A department within the firm.
The basic principles of capital investment decision making are used in corporate merger and acquisition evaluations. However, this analysis is not as easy as that for capital project investment, owing to the complex tax, legal, political, personnel, and accounting issues which must be considered. Most corporations, without a merger and acquisition staff, rely on the expert advice of investment banks in dealing with these complex issues.
INTERNATIONAL FINANCIAL MANAGEMENT
The above discussion of financial functions has ignored the possibility of international corporate activities. Although basic objectives in international financial management are the same as domestic objectives, some specific problems typically addressed by an international financial management group are described below.
The unique feature of international financial management is that more than one currency is involved; hence, various exchange risks exist. One function of the international financial manager is to reduce these risks through various foreign-exchange market operations, commonly known as "hedging."
Another important aspect of an international financial manager's function is to concentrate the company's financial investments in countries with the least risk and most favorable interest rate. On the other hand, an expansion strategy often evolves to spread investments to various countries to reduce the total risk of the investment. As an international financial analyst you would be responsible for analyzing the factors involved in investing in various countries and recommending strategies accordingly.
In addition to currency management, international financial managers must consider the problems in the capital budgeting and project financing processes. Typical questions include: What discount rate should be used? Should the company finance the operation locally? How does the financing method affect the project choice?
Working in an international financial management unit may involve travel in order to analyze potential projects. Otherwise, your work role and responsibilities are similar to those of positions in capital budgeting.
