CFO Chats: Improving Return on Invested Capital

by Bill Bosco Nov/Dec 2023
In the third edition of CFO Chats, Bill Bosco outlines a conversation between a salesperson and a CFO who is working on a new task force to improve their company’s return on invested capital.

Bill Bosco,
Leasing 101

This continued Monitor column is another slice in the life of a leasing sales person.It is a fictitious sales call between a leasing salesperson and a CFO prospect. This could be a face-to-face sales call or a quick phone call to see how the customer is doing and if there are any new problems the CFO is facing or new projects that may spell new business for the lessor.

Mid and large ticket leasing salespeople must know more than just their products and pricing. They must be able to probe to identify and solve customer problems by offering the structure that best serves the customer’s needs. Leasing salespeople also need to understand corporate finance and financial reporting issues that are concerns of CFOs — this is complex, but important to arrive at the best structure.

So here we go with the third CFO Chat.

Leasing Salesperson: Good morning, how are things going?

CFO: I’m busy with a new project. Our CEO and I noted that our return on invested capital (ROIC) is low compared to our peers, so I am working on a new task force to improve it.

Leasing Salesperson: I’m happy to help. How you finance the use of assets impacts ROIC as well as your weighted average cost of capital (WACC). They are among the key measures that drive your stock price. ROIC is an important indicator of how effective a company is at turning capital into profits. Since return on invested capital is said to measure the ability of a firm to generate a return on its capital, and since WACC is said to measure the minimum expected return demanded by the firm’s capital providers, the difference between ROIC and WACC is your economic profit. The higher, the better for your share price.

The heavy lifting in improving ROIC is in the hands of business management, as they have to find ways to innovate, raise revenue, increase efficiency and manage costs. A CFO’s ROIC improvement job is easier, but also very important — you just have to choose the right financial products to finance your business assets. The objective is to reduce the amount capitalized as assets and thus included in “invested capital,” the denominator in the ROIC calculation, such that ROIC improves. An optimally structured lease versus borrowing to buy will result in capitalizing less than the cost of the asset. Of course, you also want to get the lowest financing cost.

The lower the amount capitalized from the discounted lease payments, the less equity needed, so ROIC as well as WACC improves with leasing. I can show you lease structures that minimize the amounts capitalized under the ASC 842 lease accounting rules. Credit analysts and investors have always made adjustments to ROIC to reflect capitalization of leases, so this is nothing new. However, with the capitalization of leases by ASC 842, there are no estimates needed by the analysts. Your job is to choose the “lowest capitalization” structure for your leases, and I can help with the structuring. You also want to retain some control over the leased assets, and I can include purchases options and renewals in the structures.

CFO: We do have some upcoming projects. We are looking for a distribution center in Chicago as we are expanding in the Midwest. We also need to increase our truck fleet and material handling equipment.

Leasing Salesperson: I think you should consider a synthetic real estate lease for the distribution center. You must avoid sale leaseback issues, so line up a leasing company before you do anything that puts you in the chain of ownership of the building, like committing or disbursing funds. The typical synthetic real estate lease is a five-year lease with purchase and renewal options. It capitalizes at about 26% of the asset’s cost and can be structured as an operating lease, or a finance lease if EBITDA (earnings before interest, taxes, depreciation and amortization) is a concern. For the trucks and other equipment, you should also lease to reduce assets on balance sheet. I can show you different lease options and help create proforma financials comparing the impacts to ROIC and WACC for a loan, operating lease and finance lease for each of the asset types.

CFO: This is complicated. Let’s work together on the analysis.

ABOUT THE AUTHOR: Bill Bosco is the president of Leasing 101, a lease consulting company. Bosco has nearly 50 years’ experience in the leasing industry. His areas of expertise are accounting, tax, financial analysis, structuring and training. He was on the Equipment Leasing and Finance Association’s accounting committee from 1988 to 2017 and was chairman for 10 years. He is a frequent author and speaker on leasing topics. He was selected to the FASB/IASB Lease Project working group as a lease accounting expert to represent the ELFA and to aid in the development of the Lease Accounting project. He can be reached at [email protected].

Leave a comment

No categories available

No tags available