In Focus

The Modern Finance Function

Adaptability, ingenuity and resilience have been the watchwords for businesses as they operate in a world that seems to have been in a perpetual state of crisis ever since the arrival of Covid-19.

The challenges of coping with the pandemic and further serious problems such as the energy crisis, supply chain disruption and the return of high inflation have prompted fundamental shifts in how some finance departments act as stewards of corporate capital. This unrelenting barrage since 2020 has prompted them to take a broader view of business risk, liquidity management, scenario planning and other key aspects of their work.

Moreover, other business functions are coming to view the finance team as a valued ally that should be constantly involved in projects, rather than a dispassionate arbiter to be shown only fully formed plans to approve or veto.

Engagement across the organisation

Some senior finance professionals believe that the constant challenges of the 2020s so far have obliged their teams to improve the quality and quantity of their communications, both internally and with the rest of the organisation. This has altered both how financial managers approach their work and how their non-financial colleagues perceive them.

Fionán Dunne, CFO at identity-verification specialist ID-Pal, is one of them. He says: “Finance people have traditionally focused on efficiency, but there’s been a realisation that they must take a broader view. Having spoken to peers, I think that our function has become much more engaged across the organisation and it’s getting involved in projects at an earlier stage. We’re coming to be viewed as collaborators rather than gatekeepers.”

Dunne adds that finance teams are more routinely taking a “business first, numbers second” approach. By this, he means that they’re balancing their core responsibilities of fiscal prudence against the growing onus on them to help the enterprise achieve its commercial objectives in difficult trading conditions.

Prioritising the wider business strategy

By taking a broader view of the organisation and its markets, a finance team can analyse, support or make choices in alignment with the corporate strategy.

Claire Trachet is the CFO of bug bounty platform YesWeHack and an independent consultant who specialises in advising hi-tech scale-ups. She says that, having weathered various crises, corporate finance teams are treating matters such as expenditure and liquidity more holistically. For instance, an FD might favour taking out a short-term lease on an office that may be more costly than a longer one, yet offers the business more flexibility than it would otherwise have.

Trachet believes that CFOs are “even more strategic” than they were before the pandemic – and that their increased involvement in corporate decision-making is a generally positive trend. She adds that scenario planning has become more comprehensive since the Covid crisis, with finance teams considering a wider range of potential situations and responses.

“Deciding where to focus your firm’s resources is vital to giving it a good chance of success,” Trachet says. “Businesses are trying fewer things but they’re putting the right resources behind these efforts. This is about managing risk from a cash and opportunity perspective.”

Julien Lafouge, CFO at software developer Spendesk, says that the number and scale of the problems that most firms have faced over the past few years should have made them wary of prioritising growth at all costs. When problems are coming at you thick and fast, it’s important to retain a reasonable amount of liquidity, he argues.

“One lesson that holds true for everyone is that you should raise money whenever you can, even when you don’t think you’ll need it all imminently,” Lafouge says. “The better capitalised you are, the better you’ll be placed to go through any type of crisis.”

He points out that, even in exceptionally difficult markets, funding is usually available for the right businesses, adding that “the winners going out of a crisis are very often determined by what they do during that crisis”.

Spendesk, for instance, is establishing a presence in both Spain and Italy, despite the economic uncertainty. The business believes that it will have solid foundations to build upon in those markets when trading conditions eventually improve.

The need for liquidity awareness

In light of the recent collapses of Silicon Valley Bank (SVB) and Credit Suisse, many corporate finance teams have yet another risk to address. They must decide not only how to spend the cash their firms have raised, but also where they can safely deposit that money while they consider their options.

“When I was in San Francisco recently, SVB was the talk of the town,” reports Andrew Birch, co-founder and CEO of OpenSolar, a developer of free software for solar tech installers. “Young firms used to feel positive after raising money. But, given what happened to SVB and Credit Suisse, every startup has a finance team scrambling to open new bank accounts.”

He continues: “They’re putting cash into money market funds and US Treasury securities, which they wouldn’t even have considered a few months ago. But now they see a bank run, which can happen overnight, as an existential threat.”

Birch stresses that financial flexibility has become a “big thing” for firms, adding that the “core lesson of the recent drama has been that revenues can drop very quickly. Having minimal fixed costs is a crucial aspect of surviving as a startup.”

Shared experiences and a sense of community

Have larger companies been reacting to such problems in a similar way? 

“It’s incremental, in that they’re more likely to be managing the portion of costs that are fixed rather than recreating the business,” Birch says.

Nonetheless, businesses of all types and sizes are trying to amass larger liquidity buffers where they can and are focusing more closely on cash, according to Dunne. This defensive response could partly dictate how finance teams approach their work over the next few years. 

He adds that “a sense of community has also prevailed more than it would have done before the pandemic. This has manifested itself in suppliers helping out their customers, with everyone in the supply chain working together so that as many members of it can survive as possible. That builds loyalty and will help in the future.”

In March, having posted a loss of £234m for 2022-23, the John Lewis Partnership announced that no annual bonuses would be paid for only the second year since 1953, warning that its situation had become so dire that jobs were at risk. 

The retail group’s 100% employee-owned (EO) model has been one of its biggest differentiators since this was established in 1929, while its stated purpose of “working in partnership for a happier world” has helped to keep its 74,000-strong workforce engaged. Its much-admired partnership structure has endured several economic downturns over the decades, but the business has fared so poorly in the past three years that the leadership team has been forced to consider a radical departure: giving up a minority stake to external investors in return for a sum approaching £2bn. 

The 2020s have been challenging for many businesses so far, serving up crisis upon crisis. Will other EO firms need to consider a similar move to recapitalise, improve their liquidity and survive this especially difficult period? And is the mutual model in general still fit for purpose?

Although research jointly published by the Employee Ownership Association suggests that EO businesses were more resilient than their conventional counterparts to the great recession of 2008-09, Chris Percival, the founder-CEO of management consultancy CJPI, believes that the EO structure tends to make life harder for firms in urgent need of a cash injection. 

“While the partnership model offers clear benefits, including long-term focus and loyalty from employees, it often limits access to capital,” he says. “This can make companies with these schemes less robust in weathering significant downturns in consumer demand and leave them facing increased financial stress.”

The challenges of raising new finance

Freddy Khalastchi, partner and business recovery specialist at accountancy firm Menzies, agrees.

“These businesses have fewer options for raising finance. They will either rely on existing stakeholders to invest their own money or, possibly, restructure if they can’t enter funding agreements with potential investors that don’t require an equity stake,” he says. “Putting investors’ cash in the bank would be one way to shore up the finances. This would help to quell any creditor concerns that might be brewing and enable the management team to focus on improving performance and profitability.”

Percival notes that the expectation on EO businesses to share out rewards can also be problematic when times are tough. If maintaining liquidity is a concern, bonus payments are likely to be reduced or even scrapped, as in John Lewis’s case this year. This is clearly bad for morale and demotivating for all concerned. 

“Many of the benefits of a partnership structure are amplified during strong economic conditions, but they may become the perfect storm in a downturn,” he says.

The dilution of employee ownership

Many EO enterprises, including the John Lewis Partnership, are likely to be culturally invested in mutuality, according to Khalastchi. Diluting that structure may be unavoidable if they’re to survive the ongoing cost-of-doing-business crisis, but the idea of granting external shareholders a say in how the enterprise is run and a share of its profits constitutes an unpalatable last resort for some adherents of employee ownership. 

They may view it as an admission that this egalitarian ideal is impossible to maintain when the going gets really tough. Yet other keen proponents of the EO model are more pragmatic in their approach. Chris Maslin is one of them.

In 2021 he transferred a controlling stake in his accountancy firm, Maslins, to an employee-owned trust. As the founder of the Go EO consultancy, he now specialises in helping other SME owners to follow suit.  

“I don’t agree that one model somehow needs defending against another,” he says, noting that, in John Lewis’s case, “it’s simply that one type of shareholder is considering whether seeking investment from another type may be beneficial. In effect, the staff here at Maslins are the shareholders. They collectively control the business and are entitled to any profits it makes. The situation would be no different if the shares were owned by, say, a few rich individuals, a private equity house, a venture capital fund and so on.”

Preparing to pivot

Maslin stresses that any business planning to adopt an EO model must ensure that flexibility is built into the arrangement. It should put robust frameworks in place that fully consider the implications of employee ownership when planning for various financial scenarios and conducting stress tests. 

It will also need to establish an approach to managing employees’ concerns when trading conditions deteriorate and demonstrating that the benefits of a mutual model aren’t going to vanish overnight if adjustments need to be made. The finance chief can play a key role here in reassuring people in an EO firm facing the prospect of a change in its ownership structure.

“The company’s finance leader may well be expected to put together some projections that will help to show its staff that, if a certain equity investment is taken on, yes, someone else will be entitled to a percentage of profits but this may well be a small price to pay if that investment makes the business more prosperous,” Maslin says. “Simply put, it’s better to have 90% of a profit than 100% of a loss.”

When Silicon Valley Bank (SVB) collapsed in March, sparking turmoil in the global banking sector, it left analysts questioning why the US lender’s problems hadn’t been spotted sooner. 

Several increases in the US Federal Reserve’s base lending rate over the preceding months had reduced the value of assets held by SVB, causing big losses on its balance sheet. This triggered the run that brought it down. 

But the rate rises were by no means a surprise development. From as early as Q1 2022, it had been widely accepted that the Fed would need to make such calls to counter the unwelcome return of high inflation. Moreover, SVB supposedly had systems in place to detect risk and a board to oversee its operations. The bank’s auditor, KPMG, had even given the business a clean bill of health only two weeks before its demise.

The SVB affair has naturally put a spotlight on corporate risk at a time when trading conditions are toughening for companies of all kinds. Persistently high inflation and rising interest rates are reducing the ability of UK firms to repay loans and secure more finance, leaving them more vulnerable to shocks. 

What, if anything, should businesses be doing differently to protect themselves?

Preparing for risks of all kinds

Given the latest data from the UK Insolvency Service, it’s not surprising that financial risk is becoming a significant concern for British businesses. In March, the agency recorded 2,457 corporate insolvencies – the highest number since it started compiling comparable monthly data and 16% up on the total for March 2022. 

But Tina McKenzie, chair of policy and advocacy at the Federation of Small Businesses, stresses that firms should be preparing for “risks of all kinds”. By this she means both “nipping problems in the bud before they become existential threats and identifying new opportunities to save costs or potential sources of extra profit”. 

Businesses are also increasingly being held responsible for what happens in their supply chains. The potential ramifications of a compliance failure, wherever it may occur, can be extensive, warns Adam Garside, director of forensics at risk management consultancy Control Risks.

“Financial penalties aside, the reputational damage from an incident – be it a data breach, a bribery investigation or a product safety issue – can devastate an organisation and its ability to fully recover,” he says.

Stay flexible and well funded

Garside adds that the good news is that regulatory compliance remains high on most firms’ agendas and tends to be a properly funded function. Many companies also have dedicated teams whose job it is to provide an overview of the most relevant risks and opportunities while ensuring that regulations are adhered to. 

These enterprise risk management teams tend to be small, with roles within them varying according to the firm’s priorities. But they will typically engage with members of the C-suite and the board. 

Anna Walker, a director at Control Risks, adds that the risk registers that firms have traditionally kept to log the known threats to projects may no longer be fit for purpose, given the speed at which interconnected factors can develop and jeopardise an operation. She recommends exercises such as scenario planning and horizon scanning as more constructive ways for businesses to “build resilience”.

Auditors – the third-party sanity check

Most big companies rely on their external auditors to help them manage risk. As well as ensuring that their client’s financial statements are in order, auditors are supposed to spot weaknesses in its processes and highlight potential compliance problems. Yet recent high-profile corporate failures, including that of SVB, have prompted businesses to question the efficacy of auditors and reconsider how best to manage the relationship with them.

Nelson Wootton is the co-founder and CEO of SaaScada, a banking technology platform that helps companies to manage risk. He says that a good auditor acts as a “sanity check, offering a valuable second pair of eyes to challenge the assumptions made within your business”. But he adds that the client must adopt the right attitude to get the most out of the relationship with its auditor. 

“Boards need to see auditors as trusted business partners. They must be prepared to listen to them and be open to getting challenged,” Wootton stresses. “If boards see auditing as a regulatory box-ticking exercise, rather than a way to safeguard the business from risks it may not have considered, they will gain only limited value from the relationship.”

Letting technology take the strain

Companies that have invested in the latest IT to bolster their risk management processes are seeing strong results. Systems using artificial intelligence, for instance, are proving effective in identifying threats to data privacy and regulatory compliance, reports Craig Earnshaw, senior MD in FTI Consulting’s technology practice. 

“In an investigations context, advanced analytics and machine learning technologies are helping businesses to reduce risk,” he says. “They do this by filtering through huge volumes of data from hundreds of sources in myriad formats to uncover key facts, such as who was involved in a case of leaked intellectual property. The ability to find accurate information quickly helps organisations to understand the details of an incident faster than they could ever do using manual methods.”

Similarly, the latest AI systems can help compliance teams to scan their organisations’ communications for so-called behaviour anomalies. Some, for instance, can learn to detect signs of attempted fraud or other non-compliant activities in emails or chat messages.

Building an open working culture

Although strong risk management practices, an effective auditor and powerful technology are important, none of them will make much difference if the business using them has a culture that discourages people from putting their heads above the parapet. All employees need to feel free to report any concerns they have about a threat to regulatory compliance, say, without fear of a negative reaction. 

For risks of all kinds, “sunlight is the best disinfectant”, McKenzie says. “A culture of healthy challenge is sometimes tricky to achieve, but it will deliver dividends.”

Garside agrees, noting the importance of creating an environment where all employees “take ownership” of risk in their functions and where risk management processes are subject to “continuous review and improvement”.

He adds that developing a culture in which the leadership team “welcomes the reporting of compliance issues doesn’t happen overnight. This process should be approached with care, commitment and consistency by both the leadership and the management, particularly where it’s often in direct conflict with profitability.”  

Multinational companies are facing the biggest shake-up of cross-border tax regulation in years. The OECD has proposed reforms to the rules that its member states and several other nations, including G20 countries, had signed up to in 2015 to counter base erosion and profit shifting (Beps). 

Known collectively as Beps 1.0, these were designed to ensure that multinationals would pay their fair share of tax wherever they made their money instead of moving profits to different jurisdictions to minimise their liabilities. The OECD has estimated that profit-shifting practices cost about £190bn a year worldwide in lost tax revenue.

The OECD’s proposed changes – Beps 2.0 – are grouped into two pillars. Those in the first focus on redressing the main shortcomings of Beps 1.0, which didn’t account for how to tax firms operating in the digital economy. This deficiency led some countries to impose unilateral measures that created double-taxation problems. The updated rules mean that any business turning over at least €20bn (£17.7bn) globally a year won’t necessarily need to have a physical presence in a given country for it to owe tax there. 

The reforms in the second pillar are wider-ranging, introducing a global minimum tax rate of 15%. Any multinational generating €750m-plus in annual revenue will be subject to this in every jurisdiction where it makes a profit. That is likely to apply to thousands of companies around the world.

Firms are still waiting for formal guidance

The OECD had originally intended the Beps 2.0 rules to take effect this year, but delays in passing local legislation have meant that the deadline has been pushed back until the start of 2024. Those setbacks have also made it hard for businesses to prepare fully for the changes.

“Until you see the draft legislation and receive formal guidance for each country in which you operate, there’s very little that you can do,” says John Weybourne, global head of tax at financial services provider Apex Group. “It’s simply been a case of monitoring the proposals from the OECD and waiting for legislators around the world to take the blueprint and pass it into law. Only once that information is available will people know what they must report and where.”

Catherine Hall, international tax partner at accountancy firm Mazars, observes that companies have tended to approach the situation in one of two ways. Some have been engaging with the OECD from the start and are much further advanced than most with their planning, if not necessarily their implementation. Others have adopted a more relaxed attitude, given that there will be a three-year transition period during which there is no risk of being penalised for compliance failures.

But the latter approach may be problematic, because auditors will start asking from next year to see evidence to support the positions businesses are taking, she warns.

Where will the difference be paid?

There is also uncertainty about the information that companies will need to provide to comply with the Beps 2.0 rules, Hall adds.

“There’s a big exercise to be done in terms of data,” she predicts. “Taking what data you already have for things such as country-by-country reporting (CBCR), it will undoubtedly not have everything you need. That’s because CBCR reports income and doesn’t report the tax level – and those don’t always match up.”

This means that companies will need to figure out what information they are missing and where they can find it.

“Businesses should not assume that their existing accounting and enterprise resource planning systems will easily provide the data required,” warns Emma Locken, corporate tax partner at accountancy firm Crowe. “It will be important to understand where gaps in the systems could exist and what modifications may be required to capture the data.”

Other unanswered questions are fuelling debate, particularly when it comes to jurisdictions with corporate tax rates of under 15%, where top-up taxes will therefore need to be paid. Take Ireland (12.5%), for instance. It has yet to be established whether a multinational profiting there would be expected to pay the extra 2.5% in Ireland or its home country. That could have significant implications for emerging economies that have adopted low tax rates to boost their competitiveness. 

“There is concern that these rules could be perceived as a cash grab by the G20, because multinationals are headquartered in its member states,” Weybourne says. “For developing markets that are using lower tax rates to attract investment, that might be a little unfair if the additional tax ends up in the countries where those companies are based.”

The burden on compliance teams

The ongoing lack of clarity is also making it hard for multinational businesses to make long-term tax plans.

“Until it becomes clear as to how different territories will implement these provisions domestically, you can’t plan for what the impact will be on your tax strategy,” Hall says. “But we always say that your strategy shouldn’t drive what’s happening with the business anyway. It should be a question of asking ‘what is the strategy for the business?’ and then making it as efficient as possible from a tax perspective.”

However the laws end up being applied locally, the new rules are likely to have a significant impact on finance departments. Locken believes that many teams are “likely to be under-resourced in terms of both assessing the impact of pillar two and having the right training to manage the ongoing compliance and reporting requirements.”

Some businesses have started strengthening their compliance teams in anticipation of the extra workload. Apex Group is one of them, as Weybourne reveals.

“I’m already recruiting extra resources to ensure our compliance with Beps 2.0 and what it’s going to introduce,” he says. “The volume of work is likely to be onerous. You’re looking at potentially having to use different reporting requirements, disclosures and software in each country of operation.” 

Weybourne adds that he doesn’t expect the new rules to have a material impact on where multinationals choose to do business.

“This is really a compliance and admin burden, rather than something that’s going to really move the needle from a tax structuring and investment perspective,” he predicts.

It seems that, while multinationals will inevitably end up paying more tax, the task of complying with Beps 2.0 is set to cost them plenty too.