The Difference Between Operating and Strategic Finance

Stuck in the day-to-day numbers? You might be missing the bigger picture. In this video, Steve explains the difference between operating finance and strategic finance—and why making the shift is key to unlocking growth and long-term value.

Most business owners focus on budgeting, expenses, and short-term profits. But strategic finance looks deeper—connecting financial decisions to business strategy and helping you build a company that lasts.

If you want to stop leaving money on the table and start leading with intention, this is the shift you need to make.

TRANSCRIPT:

If you're running a business, I know the financial and accounting side of the company can be confusing and it can be this black box. Today I'm going to talk about how you can improve the accounting and financial side of your business to make it more powerful and to increase value. Now this is something important you need to understand.

I'm going to draw a triangle. I don't know if a triangle is the shape necessarily, but this is how I kind of see it in my mind. At the very top of this triangle we have firm value and ultimately CEOs and business leaders are increasing firm value and if not they should be, right? But they go about it the wrong way and that's what I want to talk about in today's video.

I want to compare and contrast operating finance versus strategic finance and I'm going to keep it really simple, okay? So I would say the majority of businesses operate in this area. I'd probably say 75 to 85 percent of companies live in this world of operating finance. It's okay, no harm, no foul, no shame, all right? It's not your fault.

This is where a lot of businesses start and they just stay stuck in this area because they were never taught differently and in most business schools they teach operating finance to students and guess what? These students get out of school, they come into companies and they become managers and leaders of the accounting and finance departments and guess what? They just stay stuck in this operating finance world.

Now over a decade ago I started talking about this concept called strategic financial leadership and it really caught on and anytime I did a session at a conference it was very well attended. Not because of me and certainly not because of this bald pale head of mine but instead I think the world is starving and they're craving this combination of strategy and finance that I talk about so often but most of the time business owners and leaders they don't know how to get unstuck from this side of the business because it's all consuming.

All right, let me explain what operating finance is. Here's some things that could be happening in operating finance that sound familiar. So just the accounting and the bookkeeping portion of the business exists in operating finance. So this is when you're doing you know the debits, you're doing the credits, I can't even speak when I write, here's the credits, here are the debits and you're going through the bank statement, you're ticking and tying it, you're reconciling it, you're getting receipts right from employees and you're recording these receipts into the accounting system. Here's the accounting system here and this is just the debits and credits, the compliance transactional side of the business and this is definitely the foundation of operating finance.

All right, so in addition to this there is financial reporting that lives in operating finance. Very important but sadly most accounting departments only produce an income statement, sometimes they'll produce a balance sheet but very rarely do they have all three financial statements, the income statement, the balance sheet and the statement of cash flows which is super key.

All right, another activity may include budgeting. I can do a whole nother video on budgeting itself but in this function they create this calendar, your budget, it's more of a performance contract where senior leadership, they set these targets, they cram the budget down the throats of middle management and they're like okay we're going to measure variances and hold you to it, not very effective. All right, but I won't go too deep into this because I'll go on a serious rant. All right, I want to avoid that.

All right, so budgeting, measuring variances is another activity found in operating finance, you also have cost control which isn't a bad thing but this lives in operating finance and then finally just all other activities related to compliance and risk management, compliance, filing taxes, etc and then just mitigating risk.

These activities are critical because if you don't have operating finance and if this side of the business isn't buttoned up, guess what, you're gonna have some serious problems but what I found from my experience as a CFO running both small and larger organizations is that the people in this department, right, living in operating finance, they are so overwhelmed, they're so stressed, they work all hours of the day, that's a clock, right, they're just working all hours of the day, they're stressed, they're overloaded, they're just trying to get their financials out in a timely manner and keep their budgets up to date, let alone trying to manage cost and if they get to it, manage cash but this is poorly done in this space and what happens is that business leaders and their teams are so overwhelmed and they're buried by compliance and transactional activities that they never escape out of this area and so much money is left on the table.

That's why I'm so passionate about strategic finance and that's what we do at Coltivar. We go into companies with operating finance in place and then we help them to elevate and move up the triangle here so they can increase more firm value.

So here are some activities that exist with strategic finance. I always say finance but my kids give me grief, they're like, dad, it's finance, not finance, so I'm trying to be good here but it may slip every once in a while when I say finance, not that there's anything wrong with it but there you go.

All right, one of the things may be capital allocation. So you have this money, right, from cash flow, how are you going to allocate it? That's an important part of strategic finance because there may be certain projects with higher ROICs, return on invested capital, compared to other ones and there may be projects that spin off more cash flow than others. So understanding how to allocate capital efficiently and to align it with a company strategy is a really critical activity.

Next, there's business growth. I'll just abbreviate here and draw little symbols, business growth and valuation. So when I go into a business, I like to identify what is their value today, what is their potential value and what's in between here is this gap. And oftentimes when I go into companies, they may have a value of like one million dollars, I'm just using easy numbers to follow, and their potential value may be eight million dollars and all they need to do is to fix a few things in the business, enhance EBITDA and to maximize the value that they're getting on their profit and their cash flow and it will make all the difference in the world.

But they're so busy, just stuck down here in operations, whether it's operations of the business or within operating finance, that they never get here and they leave so much money on the business. I'm guessing the same thing is happening to you, which like I said, it's not your fault. All right, you're not alone. A lot of business owners struggle with the exact same thing. So I'm going to help you to get out of this and to start focusing on more activities related to strategic finance. See, I just said it.

Okay. Now, another thing that happens in strategic finance is performance management, which includes tracking KPIs. Now, you can't just create a bunch of random KPIs, these KPIs have to relate back to the strategy of the business, that's really critical.

Right. Another activity may be investor relations, communicating with investors, setting clear expectations, updating forecasts, getting them whatever they need on their end, right, to be successful and happy investors, that's always good.

And then right here is strategy. And I talk a lot about strategy and finance in my videos, in my content, because I believe it's a critical part of the business. And if you have strategy and you combine it with finance, then all these other things start working together. And guess what? You're able to increase firm value.

All right, let me give you a little bonus here before we sign off. The reason why this is so critical, and I talk a lot about this in my book, Cash Flow, right, is this. Did you know that if you grow your business and you grow it too quickly, you may grow yourself out of business into bankruptcy? And how do you know that?

So here's a little bonus. So I talk about return on invested capital oftentimes. And return on invested capital can be defined by taking NOPAT, net operating profit after tax. So this is profit that comes from operations, net of tax. And if you divide this by your invested capital, right, invested capital is a combination of your working capital, working capital plus your net PP&E, which stands for property, plan, equipment.

So if you go to your balance sheet and you just take your current assets minus your current liabilities, and then you take your net PP&E, which is your gross property, plan, equipment, it's in your balance sheet under the asset section, and you net out depreciation, you come up with net PP&E. Combine these two numbers together and that will give you your denominator, invested capital.

This comes from your income statement. This comes from your balance sheet. Do the math here and check this out.

Let's say you come up with 15% by doing the math. I just made this up. Well, that's good because the market, the S&P 500 on average over the last 50 years has returned around 10%, the S&P 500.

All right. So that's good. Now, if your return on invested capital is say 6%, that means you're earning returns lower than the S&P 500, which doesn't mean you should just liquidate your business and go put all your money into stocks, but it does mean that your business is underperforming compared to the risk that you're taking on as a business owner.

But here's what's even more important. This return on invested capital, this is just one example of how strategic finance can help your business. There are so many other ways. I'm just going to give you one simple takeaway.

So if you take this, this right here, return on invested capital, and you plug it into this growth formula. So growth is return on invested capital minus your payout ratio.

Okay. Payout ratio is calculated by taking your dividends or distributions and dividing that by your net operating profit after tax. You can get your dividends and distributions off your balance sheet by finding the change period over period, or you can get it off your statement of cash flows, just depending on how you report the numbers in that report.

Okay. So you have dividends and distributions over a period, and then you take your notepad, and this tells you that you pay out 80% of your profit in dividends and distributions. Guess what? You're not going to have a lot of money left over in order to grow.

All right. So let's just go a little bit more conservative and we'll say 20% of your profit you pay out in distributions. The rest you maintain in your company.

If you take your 15% return on invested capital, and we'll just do the long math here, and you multiply it by one minus your payout ratio, that means you have 15% times 80%. I just did the inverse here because this is how much you're retaining in your business. Therefore, if I do 15% times 80%, I arrive at 12%. And this is my growth rate.

Now that might be a lot of math here. I might've lost you somewhere in between, but let me just drive home the point before we end this video.

This, like I said, is your growth rate, 12%, which means that if your business grows faster than 12% — so let's just say you're a CEO and you're like, we're going to rock it. I've been watching other YouTube videos and it's all about growth and scaling the business. And I'm going to grow it by 40% this year. And let's say you go do that and you're successful at it — well, you're going to need to make up the difference right here.

This is a 28% gap between your growth rate and your growth rate over here that you're allowed to do — that you're able to do, in other words, without taking on additional capital. So you're going to have to go bridge the gap, which is going to be 28% times your invested capital base. You're going to have to go get that in debt, or you're going to have to use the equity in your business to sustain this growth.

And if you don't, you'll grow yourself out of business. You'll go bankrupt and bust. And this is why strategic finance is so important. And that's what I wanted to drive home, especially as a point that if you don't pay attention to this part of the company — and I'm guessing most businesses out there aren't doing this, especially if you're listening to this, you probably aren't investing heavily in strategic finance. You don't have strategic finance, you don't have a team capable of doing it.

And if you don't do this, just one bad mistake, like I showed on the other page, can ruin your business. You don't want to guess when it comes to growing your company, scaling operations, and making strategic decisions. Trust me, I've been there before. It can be terrible and disastrous in so many ways.

All right, if you need help with any of this in your business — maybe you're crushing it with operating finance, but you're just stuck here — you want to do more strategic finance. You could always reach out to us here at Coltivar.

If you're not ready for that, keep consuming these videos and my other content, and I'll help you to get there. And you can learn this stuff on your own.

All right, I wish you all the best.
And until next time, take care of yourself. Cheers.