Through the course of their careers, most CFOs will manage through a range of challenges: unpredictable working capital flows, volatile raw material prices, and unwieldy tax and regulatory systems, for starters. Several CFOs and consultants identified those likely to hit full-force as we enter the second month of 2011.
1) The Economy
How could anything else be Number One, since what’s at the next turn of the economy’s rocky road still weighs heavily on nearly every finance chief? “Even though things look good now, people worry about whether it’s sustainable,” says Santiago Bazdresch, assistant professor at the Carlson School of Management at the University of Minnesota.
“Where are we going and how far are we going to go?” asks Mark Eisele, vice president, chief financial officer and treasurer with Cleveland-based Applied Industrial Technologies, a distributor of industrial products. While Eisele says that he and his colleagues are cautiously optimistic about a continued recovery, he notes that the economy has a way to go to return to its pre-recession heyday. “We’re still trying to claw back to our sales run rate before the downturn.” In 2008, Applied’s sales hit $2.09 billion; for 2010, they were $1.9 billion.
Applied isn’t alone. Factory utilization topped 80% percent in 2007, dropped to the 65% range in mid-2009, and has since rebounded to about 73%, the Federal Reserve reports. While the trend is headed the right way, “the upward slope is a lot less steep than the downward one was,” Eisele notes.
2) Increased Competition
The downturn has forced more companies to battle over the same customers. Centage Corp., which provides budgeting software for small- to medium-sized businesses, has seen heightened competition from firms that normally focus on larger enterprises. As a result, “there are no easy sales anymore,” says John Orlando, Centage CFO. While Centage’s sales grew 10% in 2010, “the sell cycle is longer and people still are cautious.”
The good news is that bank lending appears to have stopped tightening. About 86% of respondents to the October 2010 Federal Reserve Survey on Bank Lending Practices said that lending standards for firms with $50 million or more in revenue were unchanged. That compares to January 2009, when nearly two-thirds said that standards had tightened.
The not-so-good news? “A lot of new (loan) covenants are more onerous,” says Christopher Tower, regional business line leader with BDO USA. For instance, what used to be a quarterly review of business performance now may be monthly, says Orlando.
4) Exchange Rates
Large importers are starting to notice an impact from strengthening currencies in certain emerging markets. A case in point: the Chinese yuan has risen nearly four percent against the dollar over the past six months or so. “That feeds directly into the cost of our goods,” says Bill Carroll, CFO with Homedics, a Commerce Township, Mich.-based designer, marketer and distributor of health and wellness products, such as back massagers and blood pressure monitors.
To mitigate the impact, Homedics tries to include provisions within its supplier contracts that limit the factory’s ability to raise prices until exchanges rates move by beyond an established threshold, Carroll says.
5) Commodity Prices
The U.S. Energy Information Administration, in its January 2011 Short-Term Energy Outlook, predicts that the price of crude oil (West Texas Intermediate) will rise to $92 per barrel during the current quarter. That’s up from $83 in November 2010. Growing demand is one driver of higher prices, the EIA says. In addition, taxes on energy are likely to increase, given the U.S.’s budgetary woes, says Dave Hill, chief financial officer with ODW Logistics, Inc., a provider of transportation and third-party logistics services based in Columbus, Ohio. Fuel can account for 10 percent of the company’s trucking expenditures, Hill says. Any price increase cuts into the company’s bottom line.
To be sure, CFOs cheered the extension of the current, relatively low tax rates. The short-term nature of the extensions, however, is reason for concern, says Dan Bessey, finance chief of SureWest Communications, provider of telecommunications services in the western U.S. Given that most of SureWest’s capital expenditures have asset lives between 10 and 30 years, “a temporary tax structure doesn’t provide the long-term clarity we need,” Bessey says.
The complex regulatory environment within which most companies operate will continue to cause some sleepless nights. It will be a long time, for instance, before many HR and benefits professionals have identified and analyzed the ramifications of the recently passed federal health care bill, as its costs and benefits are spread over a number of years, Hill says. “We’re still trying to fully understand what this will mean to our business not just this year, but in five years.”
Bessey of SureWest adds that the preliminary rules on network neutrality issued by the Federal Communications Commission in December 2010 also are a concern. “The FCC is seeking to regulate something that doesn’t need to be regulated,” given that robust competition already exists, at least in the markets in which SureWest operates. Instead, the proposed regulation is likely to harm both providers of services and their customers, Bessey says. Among other provisions, the regulation requires providers of Internet services to publicly disclose their network management practices and performance.
8) International Financial Reporting Standards
A possible move to IFRS could bring about a change that would be challenging for some firms: the elimination of the last-in-first-out, or LIFO method of accounting for inventory. When prices are rising, LIFO can lower net income, and thus taxes, as newer, and usually higher-priced inventory is used to compute the cost of goods sold. Eliminate this method of inventory valuation, and some “companies would write big checks to Uncle Sam,” says Applied’s Eisele.
9) A Tighter Labor Market
Many companies that saw sales increases in 2010 and expect continued steady growth — positive signs, of course — now are trying to staff up to meet the forecasted demand. That’s presenting some challenges, especially for companies in high-demand areas, such as high-tech. “There’s pressure from competitors for talented people,” BDO’s Tower says. At the same time, even many firms that are seeing sales increases still feel a need to carefully watch salaries and benefits.
10) Pricing Pressures
Some customers have gotten used to bargaining hard over the past few years. During the recession, “we took our lumps and said ‘thank you. Can I have another?'” says Hill of ODW. But, that can only be done for so long, he points out. As demand for ODW’s services rebounds, Hill would like to make sure that customers have reasonable expectations of the prices the company can offer.
So, what’s to be happy about?
Quite a bit, in an atmosphere that is hardly all doom and gloom. Mergers and acquisitions are on the rise. One reason, says Eisele, is that as the economy has recovered, buyers and sellers have come closer together on prices. Applied Industrial completed two acquisitions in 2010, and Eisele expects that number to grow this year.
At ODW, Hill also is noticing signs of a rebounding economy. “We’re seeing activity unlike what we’ve seen for the past couple of years,” he says, as the excess capacity in the trucking and warehouse sectors is starting to get absorbed.
To be sure, no one is breaking out champagne bottles — at least not since New Year’s Day. But while the challenges for CFOs are many, so are the opportunities, says Tower.
Karen Kroll is a Minnesota-based business and financial writer.