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Business Cases

Stages of business case development

As a manager, it’s important to think like the chief financial officer — or CFO — of your organization, especially when you’re making a business case. When examining a business case, a CFO’s fundamental priorities are to minimize costs and risks, generate revenue, and manage cash flow. So unless you keep these priorities in mind when building a business case, it’s likely to be rejected.

You can create a sound business case in four stages. Stage one is to define the business issue at the center of your case and to identify alternative approaches. Stage two is to analyze the alternatives and choose the best one. Stage three is to prepare the case. And stage four is to deliver the case — or sell your recommendations. Skipping any one of these stages can weaken — or even destroy — your case.

Define the business issue

Start by focusing on stage one of creating a business case — the other stages will be covered later in this course. At stage one, you should take a number of actions. To begin, you need to identify the business opportunity or problem to be solved by your proposal. Next, you should develop an opportunity statement.

Then, identify the business objectives of your proposal. Finally, generate a list of alternatives to exploit the opportunity or solve the problem. Your first action is to identify the business opportunity you want to seize or the problem to be solved by your proposal. For example, you might wish to expand into a new market or react to a drop in sales.

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Managing Cash Like a CFO

Every business needs to manage its cash. Ineffective cash management can lead to lost profits, difficulties with creditors, and bankruptcy. Lack of cash is a bigger obstacle to growth than lack of profitability. Ensuring that cash flow issues don’t obstruct the organization’s progress is a top priority for a CFO.

In your own role, you should be aware of your CFO’s key cash flow considerations. This means being able to answer questions such as “Why is cash held?” “How much cash is enough?” “Can inflows be increased?” and “Can outflows be delayed?”

Why is cash held

The first question is “Why is cash held?” An organization holds cash to ensure it has four main things.

1. transaction balance — An organization needs to hold a transactions balance, which is cash to cover day-to-day transactions conducted as part of its normal operation.

2. precautionary balance — An organization should ideally hold a precautionary cash balance. This is cash to cover the possibility that the value of actual transactions exceeds the amount held as a transactions balance.

3. speculative balance — An organization might hold a speculative balance, which is cash available to enable the organization to exploit any unexpected opportunities that arise. The speculative balance is an amount above what’s required for transactions and precautions.

4. compensating balance — Some organizations keep compensating balances, which are cash balances in bank accounts that “compensate” the bank for the services provided. In some instances, banks require organizations to keep a specific amount or average balance in a low- or non-interest paying account in return for loans or services.

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Cost Structure and CFO Decision Making

A CFO is driven by the goal of maximizing profitability of an organization’s operations. And because profitability is revenue minus costs, growing revenue and decreasing costs are both top priorities.

Predicting costs

Maximizing profitability isn’t just about growing sales. The critical factor in what might look like irrational relationships is costs. This is why cost management is so important for running a profitable business.

To effectively manage and control your costs, you need to be able to predict what they’ll be. If the actual costs differ from your prediction, you need to understand what’s behind the discrepancy. So you must understand what drives costs. Any examination of the cost structure of an organization begins by making a distinction between fixed costs and variable costs.

  • fixed costs — Fixed costs are costs that aren’t directly related to sales or production. This means they don’t change or fluctuate in response to changes in sales.
  • variable costs — Variable costs are costs that are directly related to sales or production. When sales or production levels change, variable costs change in tandem. For instance, if production increases by 20%, variable costs will increase by 20%. When production decreases, variable costs decrease to the same extent.

Costs, sales, and profits

When a CFO’s working to maximize profitability, consideration is given to the relationship between costs, sales, and profits. Four fundamental principles apply. First, sales don’t affect fixed costs. Second, sales do affect variable costs. Third, breaking even requires a minimum level of sales. Fourth, profit is highly sensitive to sales changes.

The first principle, that sales don’t affect fixed costs, means that fixed costs remain constant even when sales increase. If an organization’s fixed costs are, for example, $800 per week, it doesn’t matter if sales are $0, $1,000, or $2,000 — fixed costs stay constant at $800.

However, sales do affect variable costs, which is the second principle. Variable costs increase when sales increase. When sales are $0, so are variable costs — but they increase when sales do.

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CFOs’ Roles

To start thinking like a CFO, you need a sense of what roles a CFO plays in your organization. One way to get some idea of this is by considering the kinds of questions a CFO might ask in relation to a purchase or investment decision. The CFO might ask, “What are the risks of this investment? Will there be unexpected costs? Are there better alternatives? Would there be consequences to doing nothing?”

The CFO roles most relevant to functional managers are managing cash and working capital, managing risk, ensuring compliance and financial reporting, strategic planning and decision making, and — most importantly of all — maximizing shareholder value.

The CFO is responsible for managing the organization’s cash. Cash is important for the organization’s day-to-day functioning and survival. Insufficient cash can be extremely disruptive, and can damage an organization’s ability to pay bills and procure raw materials. This can cause a sudden stoppage of services. That’s why effective cash management is a top priority for a CFO.

Effective cash management requires meticulous and continuous cash forecasting. These forecasts must be checked against actual results to monitor and improve the accuracy of the forecasting.

Managing risk for the organization is another role of the CFO. There are many dimensions to an organization’s risk, which a CFO must monitor and manage at a strategic level. Effective risk management involves three key things.

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