Communicating with CFOs Microsoft Sales Training Program Calgary – August 18-19, 2009

1. Slide Deck 1 Communicating with CFOsMicrosoft Sales Training ProgramCalgary – August 18-19, 2009 Tony Dimnik, PhD tdimnik@business.queensu.ca

2. Introductions • Name • Position • Background • When do you have to leave tomorrow?

3. Why are you here?

4. Changes in IT sales environment • Bigger deals • Total cost of ownership (longer time horizons) • More formal financial analysis of IT proposals • Involvement of senior finance executives assessing strategic IT proposals • Decentralization of analysis and decision-making • Cost savings (cut out finance staff middlemen) • Democratization of information (Open Book Management) • Regulatory and technical demands and opportunities • Increasing pressure for managing financial risk (controls) • Innovations in hardware and software (BI for the masses) • Competitive and customer pressures (more information, faster)

5. Sales must bridge the divide • IT staff focuses on IT and doesn’t know finance • Finance staff focuses on finance and doesn’t know IT • You can bridge the divide • You already know IT – this is an opportunity to learn more about finance

6. Warning - heavy agenda ahead! • Only one other group has been able to handle this volume of material • Equivalent to an EMBA course in accounting

7. Agenda • Introductions and departure times • Finance issues • Language and tools • CFO concerns • Organizational structure • Decision making tools (Multi-attribute and Discounted Cash Flow) • Fundamentals of Financial Accounting (Queen’s T-account or Q-T) • Decision making tool (Cost-Volume Profit) • Relevant costs (allocations and drivers) • Strategy and finance • Shareholder value • Control • Business intelligence from Annual Reports • Selling to the Finance Department

8. Language Which of these 150 acronyms can you use with CFOs?

9. Some accounting and finance acronyms

10. Immediate CFO concerns • Impact of global economic conditions • Financial crisis → conserve cash and reduce costs • Volume and velocity of information → simplify • Competition → pursue strategic advantages • Environmental pressures • Limits to growth • Continuous improvement • Lifecycle (Total Cost of Ownership)

11. CFO functions • Treasury • Cash and credit management • Capital expenditures • Financial and tax planning • Controllership • Cost and financial accounting • Internal reporting • Data processing • Internal audit • Communication and investor relations • Shareholder relations • Institutional relations • Risk management (CRO) • Information technology (CIO/CTO)

12. Dual role for the Controller • Financial Accounting • Entire entity • External focus • Stewardship (historical) • Designed to meet GAAP – prime directive is compliance • Management Accounting • Pieces of the entity • Internal focus • Plans/decisions (future) • Contingent design – prime directive is relevancy

13. Increasing use of analytical models for investment decisions • Models aid in decision-making • Reduces complexity by identifying key variables and the relationships amongst those variables • Involves cross-functional teams (e.g. CIO and CFO/Controller) • Generates "answers" sufficient for action • Organization-wide use of common models helps justify decisions • Persuasion and commitment • Checks and balances

14. Three types of decision-making models • Multi-attribute models • Listing and weighting of key characteristics • Scoring through consensus or means • Useful for selecting amongst implementation alternatives • Time value of money models • Cash flow focus (e.g. DCF) • Life cycle • Accounting models • Profit and balance sheet focus (e.g. CVP, ROI, ROA) • Short-term

15. Example of Multi-Attribute Model What are the implications for sales?

16. DCF is a key decision-making model • Underlies shareholder value (cash flow) • Can be used for post-investment audit (and learning) • Encourages strategic thinking by addressing structural cost drivers of investments (life cycle costs)

17. Life Cycle cost patterns 100% Committed Costs Cash/Accounting Costs Life Cycle Costs Plan R&D Design Launch Market & Support 0% 100% Investment Life Cycle

18. Present Value of $1 received in the future

19. Future dollars worth less because of RIO • Risk • Inflation • Opportunity

20. An example to help you understand NPV and IRR • Assume you put $1,000 in a savings account in a bank • Assume you get $100 interest every year • Assume you withdraw the interest • Assume you withdraw the $1,000 at the end of five years What is the rate of return of this investment?

21. Calculate the Net Present Value (NPV) of your savings account usingdiscount rates of 5%, 10%, and 15%

22. Timeline

23. Start with the Timeline • Single most important contribution to decisions • Estimate nominal dollars • Use timeline presentation format • Draw separate timelines for each alternative • Numbers are like motions for voting • Use team meetings to refine the numbers (like amending motions for voting)

24. NPV at 5% +

25. NPV at 10%

26. NPV at 15%

27. Internal Rate of Return (IRR) and NPV • If the NPV is positive then the IRR of the project is higher than the discount rate used • If the NPV is negative then the IRR of the project is lower than the discount rate used • If the NPV is zero then the IRR is equal to the discount rate used • The IRR is the discount rate that makes the NPV of a project equal to zero • What discount rate should you use?How high should an IRR be?

28. Setting the Discount Rate(WACC, Hurdle Rate) Investment Pot O' Money Equity Debt

29. WACC and Hurdle Rate • WACC is the Weighted Average Cost of Capital • Hurdle Rate is the discount rate used to evaluate investment proposals • If you use the hurdle rate to calculate the NPV of a project and the NPV is positive, the project has "jumped over" the hurdle • If you calculate the IRR of a project and the IRR exceeds the hurdle rate, the project has "jumped over" the hurdle • The Hurdle Rate is usually a few points higher than the WACC (e.g. if a company has a WACC of 12%, the hurdle rate might be set at 15%)

30. Financing versus Investment Decisions Investment Decision Proposing projects Managing projects Financing Decision Sourcing cash Setting hurdle rate Equity Debt

31. Financial Leverage Quantifies the relationship between debt and equity in the capital structure $0 debt $100,000 debt $150,000 equity $50,000 equity Level of Cash Flow Low High Low High Cash from operations $12,500 $25,000 $12,500 $25,000 Interest 0 0 10,000 10,000 Cash before tax 12,500 25,000 2,500 15,000 Taxes (40%) 5,000 10,000 1,000 6,000 Cash after tax $7,500 $15,000 $1,500 $9,000 # of shares 15,000 15,000 5,000 5,000 Cash flow per share $0.50 $1.00 $0.30$1.80 Debt creates greater risk to the company (and shareholders) Debt offers greater potential returns to shareholders

32. Capital Structure CostofCapital NoDebt ? All Debt • Firms raise cash by issuing debt and selling equity • Most firms find that the capital markets dictate the ideal or acceptable blend of debt and equity – Which company can take on greater debt: Rio Tinto or Bell Canada? Why? • Moving too far away from the target capital structure resultsin higher costs • Debt is typically cheaper but involves greater risk to the firm (and shareholders) as interest payments must be made (fixed cost) • Equity is typically more expensive but involves less risk to the firm as dividends can be cancelled or postponed when profits fall

33. Estimating the Cost of Equity Pot O' Money Equity Debt Return on equity comes from dividends and increases in share prices (bigger Pot). What return do shareholders expect from their investment? Return on debt comes from interest. The lender sets the return.

34. Beta measures the risk of shares Beta measures the volatility in the return of a share compared to the market Market up 10% Market down 10% Beta Equity A Up 10% Down 10% 1 Equity B Up 5% Down 5% 0.5 Equity C Up 20% Down 20% 2 Equity D No change No change 0 Equity E Down 10% Up 10% -1

35. Microsoft’s Beta from MSN Money .93

36. Check the Betas of your client companies http://moneycentral.msn.com/investor/research/welcome.asp

37. Dodie 2000 Kris Ashar, managing partner of an insurance brokerage, was thinking of buying a $100,000 Customer Relationship Management (CRM) system, the Dodie 2000. Table One shows the expected increase in cash flows due to the improvements in customer service of the Dodie 2000 over a period of four years. Kris was advised to use straight-line depreciation for the system for both financial accounting and tax purposes and assumed there would be no residual value for the system. Question Assuming a 40% tax rate, and a required after-tax return of 10%, should Kris buy the Dodie 2000? Calculate the Net Present Value (NPV), the Internal Rate of Return (IRR), and the payback of the Dodie 2000. Table One

38. The Dodie 2000 Cash Flows After Tax

39. CRA – Tax Depreciation http://www.cra-arc.gc.ca/tx/bsnss/tpcs/slprtnr/rprtng/cptl/menu-eng.html

40. Sample CCA Schedule for Class 45$100,000 Purchase Price,10% Discount Rate, 40% Tax Rate

41. CCA = Tax DepreciationUCC = Tax Book Value Class X Pool Class X Pool UCC UCC Investment Increases UCC Pool Disposal Decreases UCC Pool

42. NPV calculation for Dodie 2000 Payback

43. Payback for the Dodie 2000

44. 13% IRR for the Dodie 2000

45. Some DCF issues • Sensitivity analysis • Best case • Worst case • Most likely case • Critical variables • Dealing with clients • Making sales (Finning) • Negotiations (Bombardier) • Assumptions of the Status Quo • Dealing with the unquantifiable

46. Assumption of the Status Quo Estimated Flows With Investment Net Cash Flows Assumed Status Quo Years

47. The reality of declining cash flows Estimated Flows With Investment Net Cash Flows Actual "Status Quo" Years

48. True differential cash flows Net Cash Flows Cash Flow Missing From Status Quo Assumption Years

49. Status Quo questions • What will happen if we invest? • What will happen if we do not invest? • What will happen if our competitors invest?

50. Quantifying what you can • Calculate NPV with all the "hard" numbers • Identify all the unquantified benefits • A positive NPV represents the lower range of the "real" NPV • A negative NPV represents the investment required to achieve the unquantified benefits (i.e. the cost of the unquantified benefits)