Chief financial officers (CFOs) agree that the COVID-19 pandemic’s effects on companies have catalysed a major shift in capital allocation strategy. According to the 2021 Global Capital Allocation Survey by Ernst & Young LLP (EY US), in partnership with Oxford Economics, more than half (56%) of CFOs say their capital allocation strategy needs to be completely rethought, and 80% concede their existing capital allocation process needs improvement. The survey, which fielded sentiment from 1,050 global CFOs, found that, to improve long-term business performance, CFOs and their companies must:
- Define the future state of their business with greater accuracy and align their strategy with their investment road maps.
- Use the capital allocation process to drive business agility.
- Focus on the right metrics in the post-pandemic era.
"Finance chiefs say their capital allocation strategy needs an overhaul to promote business agility and long-term growth," commented Loren Garruto, EY Global and Americas Corporate Finance Leader. "CFOs should develop a capital allocation process fit for a future that may be radically transformed by the impact of digital technologies, a changing workplace and evolving business models. Striking the right balance between rigour and agility will enable companies to achieve their value creation goals while navigating short-term disruptions and capital constraints."
Aligning the investment road map with corporate strategy
As capital spending rebounds, CFOs are deciding which investments best support their corporate strategy. This poses challenges, especially given the need to keep up with rapidly evolving customer demands and competition, the difficulties of securing the necessary capital to fund all projects and finding the right balance of qualitative and quantitative metrics to track success.
With continued uncertainty, CFOs need to determine which of the many business model changes will stick moving forward. For example, the pandemic supercharged digital capabilities and remote work, and it is reasonable to conclude that businesses will continue to invest in these areas for future growth. In fact, CFOs point to digital technology as the area where investment increased the most from 2019 to 2020, and 62% say accelerated digital transformation will impact capital allocation going forward.
"As finance chiefs weigh various future market scenarios, they must align their strategy and capital allocation accordingly," said Garruto. "Not all assets or business lines will fit the future; CFOs need to identify what is necessary to meet customer and competitive demands in the future state."
Using capital allocation to drive business agility
Funding the future requires companies to make timely, unbiased decisions about how to reprioritise. However, less than half of CFOs say they can quickly assess market threats and opportunities and reprioritise planned investments accordingly. This can hinder long-term shareholder returns - only 47% of CFOs say their capital allocation process is effectively helping them meet their total shareholder return goals.
When considering obstacles, more than half (52%) of CFOs say access to data is the primary barrier to optimal capital allocation, with 42% pointing to a lack of data analysis capabilities. Advanced data and analytics tools, such as data visualisations and dashboards, can provide companies with the firepower needed to manage the vast amount of data and produce usable insights for decision-making.
"The importance of continuous improvement in the capital allocation process cannot be understated," added Garruto. "Given the speed of market change, CFOs should continually track progress to understand if decisions are being implemented effectively, make in-flight changes if necessary and conduct postmortem reviews. At the same time, CFOs should employ advanced technology, data and formalised, yet agile, governance frameworks that allow for rapid capital decision-making."
Rethinking metrics in a post-pandemic age
Companies are also being evaluated on a greater variety of metrics than in the past, creating profound effects on how performance is measured. CFOs note that a host of metrics have become more important in the capital allocation process in the past year, with qualitative metrics, such as safety and regulatory requirements, workforce impact and alignment with corporate strategy, leading the way (64%).
This may be an indication that the disruption from the pandemic is forcing more discipline in decision-making and that a broader set of stakeholders - including employees, customers and regulators in addition to the board and investing public - is demanding to understand more about the rationale behind each business decision.
"The way companies are evaluated is changing and tracking the right quantitative and qualitative KPIs are critical for creating long-term value,” concluded Garruto. "We anticipate that businesses will increasingly leverage a balanced scorecard approach - which combines financial metrics with quantitative non-financial metrics and qualitative metrics - to make investment decisions and track progress."
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