Using Capital Allocation to drive long-term value.

So how can C-suites develop the right capital allocation strategy and process while their investment decisions are increasingly being scrutinised by investors and employees, regulators and society at large?

For us at EY, it all starts with taking a step back, and having some strategic conversations at board level and beyond about what is important to the company, what your core values are, and what you want to achieve as a sustainable business that delivers value to all stakeholders.

Tough questions will have to be asked. How will your company deliver long-term value to your stakeholders? And how will your capital allocation strategy enable you to reach those goals?
 

Once that strategic direction is in place, only then can management start setting up a capital allocation framework that talks directly to the company’s goals and values and spells out how progress will be managed and measured. There’s a smorgasbord of priorities to choose from, depending on the company: contribution to society, longevity of the company, returns to investors.
 

The point is, there’s no one answer, or one-size-fits-all approach to be had. What is critical is that the capital structure, and capital allocation decisions, are consistent with strategy. When selecting key performance indicators (KPIs), CFOs need to understand what is most important to the company’s success and to its stakeholders and determine how to measure it.

CFOs are well aware of financial KPIs such as growth rate, free cash flow and return on invested capital. But other KPIs are increasingly critical. Among those that could be considered are:

• Customer value – satisfaction, trust and loyalty, and brand value;
• People value – engagement, employee loyalty, leadership, diversity and inclusion, and health and wellness; and
• Societal value – sustainability, total economic impact, carbon footprint, water consumption and ethics.

There are a host of other metrics that can be measured. For example, the World Economic Forum’s International Business Council, with support from EY leadership, has proposed a set of common metrics to spur sustainable value creation. The key is to choose the KPIs that align with the company’s long-term strategy and mission statement to make capital allocation decisions that support the aspirational future state of the business.
 

Here, a balanced scorecard approach, combining financial metrics with quantitative non-financial metrics (like efficiency and yield) and qualitative metrics (like regulatory risk and people impact), is the most effective way to strike a balance.
 

The bottom line is that the current business environment has presented businesses with a unique opportunity to improve the capital allocation decision-making process. Striking the right balance between rigour and agility will enable companies to achieve their long-term strategy and value creation goals, while navigating short-term disruptions. And our CEOs and CFOs will have far fewer sleepless nights.