Jose R Sevilla – Finance Competencies - Applications

KEY FACTORS OF

SUCCESS

Jose R Sevilla

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Strategic Business Plans

I have developed Strategic Plans for different companies in different industries such as Private

Equity, heavy equipment, advertising and construction.

Illustrations of the framework I have used to develop these strategies are:

The formulation of the firm’s future medium to long-term objectives (I defined this as 3

to 5 years).

What type of growth we are seeking i.e.: organic or inorganic.

o Organic growth can take for an M&A and the justification must be part of the

company’s strategy going forward. Also, a strategy for an M&A must be in place,

for instance: geographic roll ups or product market extension. Other

justifications to consider for expansions are :

Achievement of economies of scale

Vertical integration

Strength in size

Tax strategy

Diversification

o Inorganic growth starts by an internal assessment of the internal structure,

process and operations of the organization and based on this assessment, to

pinpoint strengths and weaknesses. Then, we can restructure the company to

achieve a leaner more efficient operation and target cost reductions opportunities

along the process. For this type of assessment I have used the principals of Six

Sigma, process work flow and efficiencies/productivity benchmarks such as

standardization of competencies, employee evaluations, pay to performance etc.

The following is an example of the work I have done in this area:

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Market Analysis – profile and understand the potential markets.

Competitor Analysis – Who are they? What are the immediate threats to the firm? I use

Michael Porter Model for this type of analysis. I simplified Porter’s model below and I

always include it as part of the strategic and annual plan. It is an ongoing process, not a

static one.

Defects per Board

Customer Pulte

Period Dec '05 - Feb '06

Number of Defects Found: 328

Number of Units Inspected: Boards 8,938

Opportunities for Error per Unit: 1

Defect per Opportunity (DPO) = 3.67%

Defect per Thousand Opportunity (DPMO) = 36.6972

Sigma Quality Level = 3.2904

(Assuming 1.5s shift)

Sigma Quality Level

36.7 DPMO

0.00001

0.01

10

0 1 2 3 4 5 6 7 8

DP

MO

Sigma Quality Level

Sigma With 1.5 Shift

Magnified Tail

36.7 DPMO

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PEST Analysis – Political, Economic, Social (legal and environmental) and Technological

position where the firm operates.

Financial Strategy – i.e.: projections and budgets. (See Business Planning)

Important factors for a strategic plan to be successful are that the Board, CEO and

Executive Committee are committed to the plan, keeping in mind that takes human and

economic resources to achieve it. Furthermore, the plan must be flexible and needs to be

revisited yearly or in the case of market variations every quarter to make adjustments as

necessary.

Business Planning

In the context of business planning I consider it to be the tactical piece for the overall company

strategy in a given time line from 12 to 18 months.

Budgets - I have develop budgets ranging from $40MM to $800MM. Budgeting

techniques that I have used are :

o Incremental budgeting – the traditional method of using historical adjusting for

inflation and expected growth/expansion. I have used this type of budgeting

with stable companies where change is gradual and well planned. I budget

revenues bases on a compound annual growth rate (CAGR) using at least 5 years

of history. Also, I take into account the input and expectations of revenue growth

from Marketing and Operations.

o Bottoms – Up or Zero Budgeting – I particularly like this technique because cost

centers must start with a base of zero and build the budget from the bottom-up

every year, meaning that they have to analyze their different activities and

expenses for the year. This technique focuses on cost awareness and follows the

firm’s action plan.

o Budgeting with rolling forecast – I use this method when business conditions are

volatile and conditions change rapidly. The technique is based on budgeting 18

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months instead of the 12 months calendar year. The budget months stay

constant, once the month is over the new month coming up is revised and

applied for the following months. The budget remains flexible and evolving with

the company situation. I have used this type of budgeting in the construction

industry.

Forecasting – I perform forecasting every month or every quarter as needed. The

techniques differ with the conditions affecting the firm. For example, if the firm is stable

and the following months look steady-state then, I use my budget as a base and input

the actuals of the current month and leave the remaining month’s business as usual or

make small changes as needed. This becomes my current forecast. For instance, if I

forecast at the end of March it becomes a 3+9 forecast, meaning that we have 3 months

of actuals and 9 months of forecast months. The budget always remains our benchmark.

Other methods that I have used in the past are least square estimation or simple

regression when there is only one variable affecting the business. However, this is very

rare and I have used it only for revenue forecasting purposes such as projecting the

impact of advertising expenditures on my revenue line.

I also have used multiple regressions forecasting when there are many known random

variable affecting the business. This is a complicated process and is mostly used by

financial institutions.

A caveat when forecasting is that it does not matter what techniques used, business

acumen, knowledge of the business and awareness of external forces must be applied in

order to come up with a reasonable forecast.

The following is an example of Sales forecasting using CAGR methodology for one of

our portfolio companies:

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Financial analysis – I have performed financial statement analysis for P&L and Balance

sheet on a monthly basis to gauge the current performance of the firm(s). Also, I have

also used financial analysis for company valuation in terms of Merger & Acquisitions

and Joint Ventures. I have performed valuation of several companies in different

industries.

On month to month basis I use the following types of analysis and metrics:

o Variance Analysis – very useful for comparing overall performance of the budget

vs. actuals vs. forecast for current month, year to date, quarterly and prior year

basis.

o Ratio Analysis - examples of the metrics I apply in my companies analysis are:

Liquidity Ratios:

Current Ratios.

Acid-test Ratios

Collection Periods.

Capital Structure and Solvency:

Total Debt to Equity.

Times Interest Earned

Return on Equity.

Earnings per Share.

Returns on Investment:

Return on Assets.

CAGR 2009F 2008 2007 2006

Sales 5.54% $13,532 $12,822 $11,776 $10,907

Weeks/per Year 53 52 52

Sales/per Week $241.92 $226.46 $209.75

Adjusted Sales for 52

weeks year 4.87% $13,193 $12,580 $11,776 $10,907

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Internal Rate of Return.

X – Internal Rate of Return.

Net Present Value on CFs.

Operating Performance:

Gross Profit Margin.

Gross Margin

Operating Profits.

Asset Utilization:

Cash Turn-over.

AR Turn-over

Inventory turn-over

ADD to AR ratio

I perform these metrics as needed in accordance with the company performance in any

given month.

Other analysis that I prepare is the Operating Cash Flow (OCF) to Net Income analysis

this is important because it flags the type of accounting being performed (conservative

vs. aggressive) and in a stable company OCF should always be greater than Net Income.

Financial Strategies are part of the business plan. In the portfolio of companies I manage,

I used financial strategies tailor-made for each company depending on their particular

positioning. Nevertheless, I will outline some of the most frequent strategic items that I

usually incorporate in the firm’s strategic plan.

o Cash Flow Management – cash is king and needs to be properly managed. My

focus is on the firm to have enough liquidity to cover their operating and debt (if

any) obligations. Furthermore, I am a believer that the firm needs to have surplus

cash in order to cover unexpected expenses, further capital requirements and

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above all to show a healthy balance sheet in case of debt acquisition or even an

M&A or JV.

o Purchases – all types of purchases including capital purchases should be

included in the plan. This strategy is designed to obtain maximum advantage of

terms of suppliers and thus, take advantage of discounts offers.

o Account Receivables – the strategy for AR relies on establishing guidelines and

processes for expedition of collection and avoiding an increment of Allowance

for Doubtful Debts (ADD) that in turn they become an expense in the P&L and

reduce profitability.

o Investments – as I mentioned previously, I am believer of cash on hand.

Therefore, a sound investment portfolio must be in place. These could be

achieved in the near term through short-term investments (which are highly

liquid) and some long-term investments such as equity purchases in other traded

companies. This boosts the financial strength and positioning of the company

among the competition.

The goal is to have a balanced and well-diversified portfolio. Something that we

must be kept in mind and must be part of the overall strategic plan of the firm is

the degree of risk the company is willing to take. I am risk adverse and therefore,

I favor a conservative approach to investment. My job is to keep and enhance the

wealth of the shareholders.

Capital Request – I use a request form and a financial model for all capital requests. All

capital requests must include a financial project analysis in order to justify the expenses.

The following is a sample of the model with the drivers used:

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The results of this model will include a summary of operating cash flows and P&L. Also,

investment measures such as NPV, IRR and ROC.

Tax Strategies – tax strategies that I have structured vary from country to country. Each

country’s tax code differs in term of profit repatriation, transfer pricing etc. Also, tax

credits are different depending on the jurisdiction. Nevertheless, the following are some

of the items to focus on when developing tax planning strategies for the firms:

o Capital equipment expense - depending on the country, deductions may be

applied for capital purchases. Some countries are very lenient on these tax credits

as they want local business to invest in equipment in order to increase

production, generate new revenue and ultimately job creation.

o Bad debt expense – as I mentioned before ADD expenses reduce profitability, we

must be aware that a tax credit may be applied in the write-off. Rules for

deductibility vary from country to country.

o Depreciation – sometimes the use of the accelerated depreciation method can be

applied in years when Net Income is increasing, however the drawback is that in

later years those tax credits will not be present and tax expenses may erode Net

Income.

Capital Project Acquisition AnalysisINPUT SHEET: USER ENTERS ALL BOLD NUMBERS

INITIAL INVESTMENT CASHFLOW DETAILS DISCOUNT RATE

Initial Investment= $0 Revenues in year 1= $0 Approach(1:Direct;2:CAPM)= 0

Opportunity cost (if any)= $0 Var. Expenses as % of Rev= 0% 1. Discount rate = 0%

Lifetime of the investment 10 Fixed expenses in year 1= 0 2a. Beta 0

Salvage Value at end of project= $0 Tax rate on net income= 0% b. Riskless rate= 0.00%

Deprec. method(1:St.line;2:DDB)= 0 If you do not have the breakdown of fixed and variable c. Market risk premium = 0.00%

Tax Credit (if any )= 0% expenses, input the entire expense as a % of revenues. d. Debt Ratio = 0.00%

Other invest.(non-depreciable)= 0 e. Cost of Borrowing = 0.00%

Discount rate used= 0.00%

WORKING CAPITAL

Initial Investment in Work. Cap= $0

Working Capital as % of Rev= 0%

Salvageable fraction at end= 0%

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o Offshore operations – I am a firm believer of this tax strategy and I have

structured it in several companies. The basic premise is to form legal entities

offshore where the actual company will reside. Even though the actual operation

is in another country, the legal entity for the operating country is in the form of a

cost center. That is, the offshore entity gives services to the operational country in

the form of marketing, IT, Finance etc. and charge the operating center through

services fees and/or transfer pricing for those services. The challenge is that the

country where the operation resides allows for such service fees and /or transfer

pricing.

The next step in this offshore strategy is profit repatriation. This is a delicate

subject so I will just mention it briefly. Below is a flow chart of how it could

(depending on the jurisdiction) work:

Operations

Stakeholders/Investors - one of my main responsibilities as a CFO is investor (our

stakeholders) relations. I am in daily contact with investor answering their questions

and appease their concerns with their investments. I write a monthly report of the

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financial result to the investor and conduct conference calls/meeting to explain the

results.

Also, I play an active role in communicating our going forward strategy and current

year plan. Although, the investors are not involved in the decision making process I try

to keep them abreast of any significant changes in the portfolio companies.

Key Decisions - I am currently a member of the board of the company and other legal

entities. I am also in the executive committee led by the CEO, and I preside over the

audit committee. Furthermore, I am a member of the acquisitions and Venture Capital

committee. In some legal entities I am the legal representative of the company.

Along with the CEO, I make key decisions regarding capital investment, company

valuation, and the strategic direction of the company. The latter is ultimately a decision

of the board and as a member I present the plans for approval.

The following functional areas report to me:

o Finance & Accounting

o IT

o Human Resources

o Administration

o Marketing & Advertising – dotted line

I manage employees in 8+ countries totaling a number of 75± headcount.

Best Practices – I have implemented best practices processes and ideas to improve

performance in a given area. The most common tool is benchmarking against an

industry standard where the company operates in order to realize savings in cost and

revenue enhancement. These also include applications of technology, project

management, management by objectives, marketing and advertising etc.

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Due Diligence – I practice due diligence for M&As focusing in factors such as:

o Baseline Starting Situation – Management briefing, data collection, functional

trends etc.

o Assessment of Market Segments and Growth Trends – External interviews,

customer and channels, validation of market size and growth prospects.

o Competitor Strategies and Technology Trends – Profile competitors’ focus and

positioning, identify major technology trends.

o SWOT Analysis – Strengths, Weaknesses, Opportunities and Threats.

o Business Plan review - Financial analysis, sales, cost, benchmarking, synergy

quantification.

o Business Strategy – test ability to execute that planned strategy, validation.

o Due diligence checklist – Legal, related parties, financial information etc.

o Integration – corporate culture analysis, employee review and performance.

Negotiations – I have successfully negotiated with government institutions, unions,

contractors, joint venture, term sheets, banks and investment banks.

Financial Information & Audit

I am responsible for the audit of all portfolio companies across the region and we deal

with two of the Big 4 CPA firms for audit and tax preparation. I am responsible for

providing the auditors all the financial information required and answering any

pertinent questions they may have regarding our current operations.

Risk Management

I have developed a risk assessment score card that includes competitive risk and

operational risk. The score card consist of the following risk areas:

o Competitive

o Economic/Political

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o Technological

o Operational

o Financial

o An example model is as follows:

Operational risk

Scenario:

Expected Product X revenues—2011

Cost of goods sold

Labor

Materials

Other direct costs

Total cost of goods sold $0

Gross margin $0

Margin contribution percentage #DIV/0!

Impact with no mitigation

Reduction in materials availability

Revised product sales $0

Revenue impact $0

Mitigation through new supplier

Reduction in materials availability

Revised product sales $0

Revenue impact $0

Mitigation of impact with other suppliers $0

Materials breakdown

% Contribution Amount

At-risk supplier $0

All other suppliers 0

Total materials costs $0

Ability to mitigate materials loss through other suppliers

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Accounting

I have designed and implemented various accounting systems with multicurrency

capabilities in different countries.

I always make sure that there exists a “paper trail” for every transaction (PO, Check

requisitions etc.)

My staff performs a bank reconciliation in local and US currency and from there we can

see our FX exposure and account for it under FAS 52.

I manage two set of books, one for financial purposes according to US GAAP and

another set for local tax purposes.

Funding

I have extensive experience in raising capital through debt and equity. I have prepared

presentations and financial models for investors, banks and investment bankers.

I have relations with investment bankers in New York, and in the Miami area. For

raising late stage venture capital or aligning wealthy personal investors.

I have also experience in mezzanine financing which is a last resort because is very

expensive.

I have bank relations with different banks in Miami and the Caribbean that could

arrange loans or back to backs in order to mitigate tax exposure. This instrument is only

per country basis. Some countries do not allow this kind of transaction.

These are a summary of my qualifications and expertise and they do not reflect a complete

scheme and depth of my experience in the financial area and as a CFO. Furthermore, it only

shows the tangible but not the intangible factors like business acumen, situational awareness

and strategic thinking.