Bridging the Communications Gap Between Finance and Purchasing

A May 4th, 2006 article titled How to Speak Like a CFO, stressed that “Too often, finance executives in Corporate America simply don’t believe that purchasing departments are really bringing in the savings they claim.  That may be because financing and purchasing don’t speak the same language.”

A December 20th, 2007 article shows that very little has changed, as “Procurement executives continue to have issues getting on the Chief Financial Officer’s agenda, leaving procurements expansive transformation incomplete.”

Since the “language” of finance is the dialect of business, this forum will hopefully empower procurement professionals in a way that will open the doors to greater understanding and opportunity.

In this inaugural post, we will highlight the five financial terms listed in the December 2007 article, with which purchasing executives should become familiar.

In the days ahead, we will review each one in detail providing a direct “translation” relative to impact from both a purchasing and finance perspective.

According to Robert Rudzki, president of Greybeard Advisors and co-author of Straight to the bottom line, here are the five critical finance terms:

1. ROIC (Return on Invested Capital): earnings divided by the total capital invested in the business (long-term debt plus stockholder equity)

2. Cost of Capital: the weighted average “cost” of debt and equity. It represents what you must earn to, minimally, cover the expectations of your debt holders and stockholders

3. EVA (Economic Value Add): if ROIC is greater than Cost of Capital, then EVA is positive (you are adding value to the organization). If ROIC is less than Cost of Capital, then value is being destroyed and – absent substantial corrective action – the demise of the enterprise is just a matter of time

4. EPS (Earnings per Share): the net income divided by the # of common shares outstanding. Typically calculated on a quarterly and annual basis.

5. P/E Ratio: The ratio of the common stock price to the annual earnings per share. Companies/industries typically “enjoy” certain P/E ratios, therefore, increasing the E (earnings) often directly equates to a higher stock price.

The two “biggies,” says Rudzki, are ROIC and EPS. Those two concepts drive C-level because they are what Wall Street and bankers are interested in. ROIC and EPS are the ultimate “report card” of senior management.

Next Post: ROIC (Return on Invested Capital)