While finances fall into the realm of a CFO, a CEO should be financially literate enough to understand the numbers and metrics, and run your business, effectively. Many of my colleagues may argue that liquidity sits with the CFO, but the bottom line is that when liquidity is lost, the next thing that gets lost is the CEO’s head. For me, the CEO is responsible for liquidity but you must decide for yourself the level of financial literacy you require from your CEO, depending on the nature of your organization. Among the 5 key areas to examine in financial literacy, is liquidity management. The CEO must protect your liquidity; this is the most sacred of functions, and here are a few questions that allow you to test their ability to keep your liquid:
- What Financial metrics do you use to examine liquidity? Where did you get these metrics from?
With this question you want to understand if your CEO is just copying the metrics provided by their bank – large bank facilities have loan covenants that include metrics that can’t be breached- often CEOs are forced to track these and as a result, they run with the bank’s preferred metrics. Then there are CEOs who are financially literate and will use their own dashboard and a splash of customized ratios, metrics, and their own management dashboard. This is a sign of a CEO who is highly capable of protecting your liquidity.
- Describe a time when you created credit enhancers to access debt facilities?
With this question, you are examining the CEO’s understanding of basic strategies related to credit enhancement and debt facility proposals, especially in a situation where the company is facing a liquidity risk. Sometimes companies will make their CFO the CEO when they have lost their liquidity. However, if your CEO has sound strategic skills and is able to be creative in their ability to access debt facilities you will not need to make such a dramatic talent choice. For example, one CEO I interviewed had $200,000 USD in cash and applied for a loan but the bank refused him. He took the cash and bought construction cranes with it, then re-applied for the loan using the new cranes as assets the bank could securitize. He was immediately approved and was given a preferential rate. This is a simple example, and savvy CEOs and CFOs can often restructure the balance sheet to make it more attractive for a bank to lend to them.
- Describe your 3-year business plan and cash flow forecast, how accurate were your actual numbers compared to your projections?
You want to look at how effective and accurate the CEO has been in their 3-year business plan. Ask to look at paperwork from 3 years ago, including the business plan, prediction, and cash flow, then audit the financials to see how accurate they were. Were they optimistic, conservative, accurate, or in the red? This issue is of the utmost importance: If a CEO is too optimistic, expecting a big influx of cash that never materializes, they can become illiquid, insolvent, and bankrupt. Also do not accept market turns as the reason for missing a target, remember an underperforming CEO will never fess up and say “I am incompetent and unable to meet my targets”, they will always be brimming with excuses such as “We were doing great but then Covid hit us and the market turned.”
- How do you discount sales forecast, provision receivables, and account for the extra padding of revenue in financial statements?
A great CEO has their feet firmly planted on the ground and will not let the optimism of their front office inflate their assumptions about the business. So, when the head of sales says that the company will be making 10 million dollars by the end of the month, the CEO, not wanting to demotivate them, wouldn’t contradict that statement, but would err on the safe side, and operate as if the forecast revenue was 6 million dollars. When it comes to provisioning receivables, your CEO will know from looking at the financial data that x% of monthly invoices are not paid, and provisions for that.
Financial statements are the place where CEOs who are not financially literate sink: The CFO comes in and states that this month’s profits were record-breaking, so the CEO starts spending more money, not understanding the difference between revenue and cash, which is a very important distinction to make. If that money is spent, the company becomes illiquid very quickly, and this is a very common instance in the business world.
- What are the 3 biggest risks to your business and what are you doing to mitigate them?
It’s important to have a discussion about risk management because managing liquidity is essentially managing risk, and here, the way they answer is as important as what they answer: Are they feeling their way through the answer, meaning that this is a matter that they have not contemplated before, or did they give you a succinct, punchy response, meaning that they spent time thinking about the matter, and are aware of the risks. You want your CEO to have created a risk culture, and an active risk dialogue in the company because those of them who are risk-aware and who create a risk culture, are those who will be successful in the long run and that’s the road to creating a sustainable business.
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