Role of Management Consulting in the Financial World - Coursework Example

Role of Management Consulting in the Financial World Is Management Consulting simply a Buzzword There has been a great debate ever since the birth of what is today known as 'Management Consulting'. Critics have labeled Management Consulting as simply a buzzword. In spite of this confusion over its importance, Management Consulting as of today is a sector with a market size of about $125 billion. In 2000, $70 billion of advice was sold over 140,000 consultants all over the world. The European Management Consulting market for instance, has grown from 16.6 billion Euros in 1994 to 48.5 billion Euros in 2004. Following table shows the change in the size of the European Management Consulting market over the years. These statistics alone are enough to prove that Management Consulting is everything over and above a 'buzzword'. Theoretically, one can understand the significance of Management Consulting only when they understand its definition at two levels. First is the basic level which looks into the broad 'functional view' of Management Consulting. According to Fritz Steele, Management Consulting is, "any form of providing help on the content, process or structure of a task or series of tasks, where the consultant is not actually responsible for doing the task itself but is helping those who are." Looking at this definition one might feel the importance of Management Consulting is over-hyped. However, it is the second definition which views Management Consulting as a "special professional service" that will help clear this misunderstanding. According to Larry Greiner and Robert Metzger, "management consulting is an advisory service contracted for and provided to organizations by specially trained and qualified persons who assist, in an objective and independent manner, the client organization to identify management problems, analyze such problems, recommended solutions to these problems, and help, when requested, in the implementation of solutions." This approach takes Management Consulting at a different level and calls it a 'professional service which can be carried out effectively only with the help of professionals.' Does Management Consulting add value "To accept good advice is but to increase one's own ability" --- Goethe Value addition is a profession in which there is transfer of knowledge from one party to another. Hence in context of Management Consulting, value addition is carried out when knowledge is being transferred from the consultancy to their client. According to Peter Drucker, "what is unique to management is that from the very beginning the consultant played a key role in the development of the practice, the knowledge and the profession of management." In Management Consulting knowledge is not only being transferred in the form of facts and figures, but also as methods, practices and their application which eventually leads to achieving the consultancy's objectives. This transfer of knowledge which finally leads to value addition exists in two dimensions. First is the 'technical dimension' which deals with finding solutions to problems relating to the nature of management of the clients. Second is the 'human dimension' which deals with the interpersonal relation in the client organization and between the client and the consultancy. In legal terms however, the implication of 'creating value' is totally different and inextricably liked with the shareholders of the company. The fact that the shareholders invest their funds in the company and take unlimited risk in doing so, makes it necessary for the company to pay due considerations to the shareholders needs. Today, the process of creating value in a financial scenario is carried out as an 'operational activity' in 3 different ways. One of them is called 'Market Value Added' which describes value as the difference between the market value and the book value of the company's equity. Another view is the 'free cash flow' approach, which takes the view that value is related only when cash produced by a company's operations exceeds the incremental investments required in fixed asst and working capital, and sees the value of a company as the present value of those future free cash flows. The simplest approach, however, is that value that is created only by making investments in which the return on invested capital (ROIC) exceeds the weighted average cost of capital (WACC). Looking at it with a national perspective, the significance of Management Consulting is also manifested in is contribution to the nation' economy. For example, in Europe, Management Consulting accounts for 0.44% of their GDP. Management Consulting Cycle: in the context of Financing Management Consulting is not a one time activity, it is an ongoing process. And just like all other processes it too comprises of various stages; thereby forming what is known as the 'Consulting Cycle'. ENTRY DIAGNOSIS ACTION PLAN IMPLEMENTATION TERMINATION Consulting Cycle First stage of this cycle is the 'Entry Stage' which is the preliminary stage in which the consultant starts working with the client. This phase is the preparatory or planning stage which involves discussions with the clients on what they would like to achieve in their organization. This stage helps in the clarification of their roles and lays down the foundation for everything that would follow. Second stage is the 'Diagnosis Stage' in which an in-depth diagnosis of the problem to be solved is carried out. For example, the job of a financial consulting during this stage is to come up with solutions keeping in mind the conflict in interests of the senior executives of an organization with that of the shareholders. This problem is covered under what is called 'Agency Theory'. Next stage is the 'Action Planning Stage' in which the consultant with the help of a wide variety of techniques chooses the solution to the problem along with alternative solutions. For example, a financing consultancy may arrive at adopting the strategy of product or market diversification from the fact that the professional mangers are risk-averse (unlike the shareholders who can easily manage risk by diversifying their shareholdings). The fourth stage is the 'Implementation Stage' in which the feasibility of the proposals made is actually checked, mew problems might arise which may lead to a modification in the original action plan. However, it has been noted that not more than 30-50% of Management Consulting includes implementation. This stems from the misunderstanding that the job of a Management Consulting ends when his proposal is accepted. A correction in this misconception is what leads to the next and final stage which is that of 'Termination'. This stage takes place once the results are achieved and hence consultants work is assessed based on this. The client may agree to enter into a long term relationship with the consultancy or terminate the project by mutual agreement. Trends In Management Consulting Growth of Management Consulting is associated with the rapid growth of management. Other reasons for the unprecedented growth of consulting were due to the change in the business environment owing to global competition and technological advances. The economic growth and stability also added to this. There was an increasing export to Eastern European countries and the upcoming accession for Romania and Bulgaria that led to increased growth investment in these countries, accounting for an overall boost to the Consulting sector. The first consulting firm, Arthur D. Little was founded in 1890's, but it specialized only in technical research. It was with industrialization that Management Consulting as a sector began to grow. By 1990's consulting became one of the most popular employment areas at top management programs. In Europe specially, the consultancy sector was growing by leaps and bounds. PA, the largest consulting firm in the U.K, had only six consultants in 1943, but 370 in 1963, and over 1300 based in 22 countries 1984. According to FEACO (European Federation of Management Consultancies Association), the size of Europe Management Consulting Market today, is worth 61.6 billion Euros. Germany followed by U.K account for the two largest markets for consulting in Europe. As against the last few years the trend is now shifting towards investment in now and long-term projects. According to Antonie Berve Mary, the chairman of FEACO, the current strength of European economy and growing interest of CEO's in innovation will be key drivers for a continued growth of Management Consulting services in 2006. In Financial Consulting Consulting in finance, including financing the enterprise and financial control of operations, also started developing rapidly. A number of the new management consultants had a background in accountancy and experience drawn from working with firms of public accountants. One such was James O. McKinsey, a protagonist of the general management and comprehensive diagnostic approach to a business enterprise, who established his own consulting firm in 1925, and today is regarded as one of the founders of the consulting profession. A landmark event was the decision of the 'Big Eight' public accounting firms to enter management consulting. Handling the genre of professional accounting and auditing, Big Eight was reduced to Big Four by 2000. In 1995, 'Strategos' came up and soon established a string presence in Europe and the West Coast. Role of Financial Consulting Financial advice, offered to firms in the form of business valuation, strategies for creating shareholder's value, M&A advisory, analysis for treasury management and economic forecasts is done with the help of 'Financial Consulting'. Financial Consultants provide this advice to money managers and corporations. Today, in Europe the composition of Financial Consulting in the Management Consulting market is 5.3%. Service Line % IT industry 25.6 Project Management 8.6 Strategic Planning/Organization Development 7.1 Financial Advisory 5.3 Outsorcing Services 19.0 Other 34.4 The European MC-Market Composition by Service Line, 2004 The role of Management Consulting in the financial world is very significant as once a consultancy chooses to solve the problems of a firm in managing their finances, it has to first ensure that their client is financially literate, otherwise it will be very difficult for them to advice them on financial matters. Financial Consultants undertake the responsibility of several functions which include: A) Imparting Financial Literacy Bookkeeping This is a conventional approach to teaching of accounting. Although one of the most fundamental requirements, this practice is time consuming. Accounting principles The financial consultants must make the client understand some basic accounting principles because financial statements otherwise will be meaningless. These essential items are- The concept of accrual and the resulting differences between 'accounting' and 'cash-flow' figures Conservatism and the lower of cost or market rule The concept of non-cash charges (depreciation and amortalization) The distinction between the company (corporation), as a legal entity, and its owners. Financial statements This involves understanding the balance sheet and the income statement form an important part of accounting. Ratio analysis Almost all financial analysis involves usage of ratio analysis. With the help of a suitable number of ratios, a firm can come to a consensus about its financial position and management. Some of these are: Liquidity This is the ability of a company to pay its bills as they become due. For companies making significant use of debt financing, the times interest earned or interest coverage ratio is equally important. Managerial efficiency As expressed in turnover. The most important ratios are accounts receivables expressed in average daily sales, and inventories expressed in average daily cost of goods sold. Capital structure the relative proportions of debt and equity funds. The actual ratio used maybe long term debt to equity, total debt to equity, total debt to total capital, or one of many other possible formulations. Profitability This is the most important area of them all. Consultants should guide the firms in arriving at the profitability of the company by finding out the earnings before interest and taxes as a percentage return of total assets. B) Working capital and liquidity management In order to survive, an organization must be able to meet all the commitments as they fall due, i.e. to pay its bills on time. The efficient management of working capital, therefore, and particularly the provision of adequate of liquidity at all times, are crucial and hence must be tackled with, with the help of a consultancy. Every manufacturing business has an intrinsic operating cycle, in which materials are purchased, stocked, converted into finished products and finally sold. Even service industries have such a cycle, though its duration is shorter. Cash flows out of the organization when purchases are made, and returns when 'accounts receivables' are collected. Consultants help clients to understand their organizations own unique operating cycle, and to find ways of increasing operating efficiency so that the cycle is shortened and cash is conserved. In most organizations, improvements of 25-40% in cash utilization may often be made up simply by careful analysis and application of common sense. Consultants are aware of the fact that the changes leading to improvements in cash utilization are as likely to be in production or other operating areas as in purely financial ones. The very fact that most managers working in non-financial do not fully understand the cash flow consequences of their activities makes this a field in which the consultant has a particularly valuable contribution to offer. Managing Cash In this genre, banks are the experts. However the consultant plays a useful role by assisting the client in evaluating the bewildering array of different packages, in which banks offer combinations of concentration banking, lock-box collection systems, remote disbursement, zero-balance accounts, intra-group payments netting, and so forth, and in finding a solution appropriate to the client's needs. C) Capital Structure and financial markets Every business organization needs an adequate capital base and an appropriate capital structure to support operations, which is easily said, but difficult to achieve in practice. Determining an effective capital structure The management of an organizations capital structure actually involves a two-stage decision process. The first task, when any new financing operations is proposed, is to review the organizations current capital structure in the light of management's policies, accepted debt/equity ratios, market conditions and, most important of all, expected cash generation and use over a period of some years. The consultants help is invaluable here. On the basis of this analysis a decision can be made whether to seek new equity funds or additional debt. Once this is complete, the second stage involves the determination of the exact type of security to be issued, and so forth. These second-stage decision areas are the distinct professional field of the investment or the merchant banker, and the general consultant ensures that the client seeks such specialist services at the appropriate time. Using debt funds The key task in capital structure management is to determine the company's debt capacity. Financial consultants face a difficulty in this area as they have to re-educate their clients away from the rules of thumb, and convince them that nothing can replace a systematic analysis. The ability of a company to use a debt depends upon its ability to service that debt which in turn depends on cash flows. But in times of high growth the attention of line management is understandably concentrated on expanding output to meet demand rather than thinking about the next downturn. One of the consultant tasks in this case is to persuade the client company to undertake a long term projection of the cash likely to be generated by its operations, not only under normal conditions, but also during periods of economic uncertainty and recession. This is likely to require the use of simulation techniques, and the development of a computer based model of the company's financial dynamics. D) Mergers and Acquisitions Mergers between companies or the acquisition of one company by another provide many opportunities for consulting work. Most of these come in the post-merger phase, there is however, one key financial task that must be undertaken before the merger and for which the consultants are often needed- the determination of the fair value of one or both of the companies involved. A consultant advises as to the method of payment to be used. Valuation of company In recommending a 'basis for valuation', the consultant pays close attention to the company's particular situation and needs. If the client is the company which is receiving the offer, then the appropriate method will be which ever yields the highest value: the consultant does not suggest a price based on current earnings if he estimates that the realizable value of the physical and financial assets of the company is higher. But when the client is the acquiring company, the situation is more complicated. The appropriate valuation method depends on the company's motives for making the acquisition, and these motives in turn will depend in its corporate strategy and long term plans. The consultant is likely to be most deeply involved when the client organization is making an acquisition for operating reasons rather than pure diversification; in order to gain additional production capacity, for example, or to acquire new products that will complement its existing product range. Some consultants have developed particular expertise in asset valuation and have become known specialists in this area. Method of payment The selection of the method of payment to be used in, taking acquisition is a highly complex question which requires both expert knowledge of the financial markets and special skill in determining the tax consequences of the different methods. Because of the complexity of the matter the consultant recommends to the client the use of an appropriate term or specials, which includes investment bankers, tax specialists and legal advisers. Acquisitions and shareholder value The objective of all managerial decisions and actions should be aimed at creating shareholders value. Hence of the most valuable services that the financial consultant provides to the client is to persuade the chief executive not to become so involved with a potential acquisition that they pay a price that actually destroys their shareholders value. E) Finance and operations: capital investment analysis Most business organizations tend to generate more investment proposals than they can immediately finance and hence they require a systematic method of calculating economic attractions of such investment proposals, a job which is carried out with the help of financial consultants. Choosing among analytical methods The consultant's first task is to persuade the client the outdated and simplistic method of investment appraisal, such as simple rate-of-return analysis or the 'years to payback' principle, are unsatisfactory and, yield misleading results. The consultant therefore, encourages the use of a technique based upon time value of money. The general term used for this approach is discounted cash flow (DCF) analysis. Sensitivity analysis Once again, this is an area in which the consulting organization helps its clients by offering the services of a specialist team in which financial consultants work closely with computer experts. In order to arrive at a ranking for proposed projects, many companies need outside assistance. The most satisfactory solution is to adopt a 'sensitivity analysis approach'. Follow-up project effectiveness Many companies, even those that have adopted relatively sophisticated procedures for the evaluation of project proposals, overlook the need for systematic follow-up and monitoring of subsequent project performance. The development and installation of a follow-up system which will rapidly pay off in the improvement of project selection, is one of the most useful tools that a consultant provides. F) Accounting systems and budgetary control Financial consultants are invited to assist their clients in the development of accounting systems by means of which various transactions are recorded, collected and classified, entered into the various ledgers and books of account, and finally used to prepare the organizations formal financial statements. Budgetary versus accounting systems Financial consultants participating in general management services activities are likely to be asked to assist in the design of budgetary systems rather than formal accounting systems. The emphasis here is on management accounting- methods of collecting and analyzing data to support internal decision-making rather than formal financial reporting. Budgetary control The consultant keeps in mind the multiple objectives that underlie any system of budgetary control which becomes his job to take care of. First of them is to manage the expenditure of funds and commitments of resources resulting from decisions in various operating areas which can place unacceptable strain on the company's financial structure. Second is to ensure that all revenue and cost items are planned and coordinated in order to make sure there exists a positive team of earnings and cash flows, and to guarantee the organization's liquidity. Finally they must monitor the entire revenue, cost and expense items and compare it with budgeted levels, and then understand and correct the variances. Consultants are aware that designing a budgetary control and management information system involves mush more than itemizing the budgets needed and deciding how often they should be prepared. Once the organizational structure is agreed, it will be necessary to design procedures for the collection and submission of data for the development and review of budgets by higher authorities and for the determination of corrective action. G) Financial management under inflation Successful management under high inflation is not simply a matter of changing accounting procedures. There are practical operating steps to be taken. In this respect, Consultants provide services to clients in many areas, primarily the following: The development of forecast of inflation rate, either by primary analysis on the basis of monetary aggregates or by combing the forecasts available from official bodies or financial institutions The incorporation of inflation expectation in the company's strategic planning procedures The modification of capital investment analysis procedures to take explic9t and systematic account of inflation expectations, particularly inflation differentials where wage costs, for example, are expected to rise more quickly than selling prices The review of working capital management procedures, in recognition of the increased need to speed up the conversion of financial assets and to minimize unproductive cash balances under inflationary conditions The recognition of the close relationship between inflation rates and interest rates, and the anticipation of likely interest rate changes in planning the company's capital structure Continuing emphasis upon the close relationship between inflation rates and changes in the value of currencies in the foreign exchange markets leading to an increase in the importance management of foreign currency exposure H) Cross-border operation and use of external financial markets Where the client company is engaged in any form of cross-border operation either selling its products and services in foreign countries or purchasing some of its materials from foreign suppliers, a number of important other complications arise. Many of the issues involved are unfamiliar to corporate executives. The field of international finance is then, a fruitful one, for the consultant with the requisite expertise. The most important issues arising in this area for the financial consultant to deal with are, determining foreign exchange exposure, hedging techniques and decisions and finally, using external money and capital markets. Determining foreign exchange exposure Very few companies engaged in cross border trading are able to invoice their products and purchase their imported supplies entirely in their own domestic currency. As soon as sales are invoiced in a foreign currency, or the company contracts to purchase items priced in a foreign currency, a foreign exchange exposure exists. Many companies are able to identify the exact extent of their exposure, and a consultant is very helpful in these cases. For this, the consultant first makes the client aware of the 3 different types of foreign exchange exposures that exist. The role of financial consulting in these exposures is as follows: The 'translational exposure' is the risk of gain or loss experienced when the assets, liabilities and earnings of a subsidiary are 'translated' from the foreign currency in which subsidiary books are kept into the parent currency. In this case the consultant is familiar of the current rules of the client's national taxation authorities and the degree of freedom permitted under those rules. Where there is no freedom of maneuver under the regulations, it advices the client to change the currency denomination of his liabilities in order to minimize the transaction exposure. The 'transaction exposure' is the risk of gain or loss involved if the value of that foreign currency with which the company is holding transactions, changes in relation to the company's own domestic currency. The consultant however does not involve much in exposures like these, as most companies are aware of such transaction exposures. The 'economic exposure' is the impact of an exchange rate change upon the organizations overall long-turn profitability, rather than simply its effect upon currently outstanding transactions. Financial consultants role in such cases are very evident, depending upon the gravity of the situation. Hedging techniques and decisions Once the foreign exchange exposures have been determined, the next step is to decide whether they should be hedged or covered, and if so, how. Many companies turn to their commercial banks for assistance. However the local bank manager has no experience in foreign exchange management. They mostly tell their clients that the latter is in the business of making and selling products, not speculating the foreign exchange markets and hence they should not cover all outstanding exposures by buying or selling the foreign currency in the forward market. Any consultant working in this area realizes that this advice is over-simplified to a very complex problem. Hence the most important service of the consultant is to show the client that there are no simple golden rules or magic formulae available, and that foreign exchange operations require a systematic step-by-step analysis and decision process. In this case the responsibilities of the consultant are to first determine the overall foreign exchange exposures and distinguish between the different types of exposures that exist. After this, the financial consultant evaluates these exposure positions in the light of best available forecasts and expectations concerning foreign exchange price movements, and decides if there are serious exposures that may produce foreign exchange losses. If so, hedging is considered. Next, the consultant considers the possibility of hedging the exposures by operational means, rather than purely financial ones. If operational hedging is not possible and some form of financial operation is to be used, then the next question tackled by the financial consultant is whether the risk is so serious as to require 100% cover, or whether partial hedging is possible. Finally, the consultant obtains from banks the best available quotation for a forward transaction, and compares this with the managements expectations about what might happen to the spot rate. Using external money and capital markets Small companies in most countries automatically and quite logically look to commercial banks in their own country as the usual source of external funds. As companies grow in size and sophistication, however, the possibility of using external financial markets presents itself. Corporate management will initially have little knowledge about these markets, and may believe them to be exotic, perhaps dangerous or open to only multinational giants. This is another area where the role of a financial consultant steps in. he points out to the client that there are a number of international financial markets- the Eurocurrency market, the Eurobond market, and several foreign bond markets- existing in various countries. Under this, the financial consultant is also aware of a particularly interesting financing technique that existed barely a decade ago, but which is now extremely important: the medium-term note (MTN). Though this area is a complex one, the consultant gives advice to the client through a mass of new terms and procedures. There is much for the consultant to learn in this rapidly developing field of professional services. Future of Management Consulting and Conclusion "The management consulting is not only a major part of practice of management. He has been, above all, central to the development of the theory, the discipline and the profession of management"- these words of Peter Drucker throw light upon the future of financial consulting. Consultancy will not merely solve problems, but will play the role of pathfinder and creator of new responses to their client's problems ands new business opportunities. According to a survey carried out by IBM Business Consulting Services in 2003, senior executives of various finance companies agreed that there has been a major change in the way of working of finance organizations all around the world. The 3 chief 'shifts' in financial organization are those of transformation of their role from a mere "policeman" to strategic business partner, change of cost base from about 3% to 1% of revenue and finally, alteration of activity focus from transaction processing to decision support and control. Such a huge modification in their style of working as led to more professionalization and hence outsourcing of as many functional activities possible, so that the financial organizations can focus on their core competencies. This will lead to an immense growth of Financial Consulting as a sector. Bibliography Stanley Zarowin The future of finance [online] available from [January 26, 2007] 1. Janko Arah General Trends in the Management Consultancy in Central & Eastern Europe (CEE) [online] available from [January 26, 2007] FEACO The Management Consulting Industry [online] available from [January 26, 2007] 2. FEACO The Management Consulting Market [online] available from < http://www.feaco.org/content/content2.phpCatID=121&NewsID=263> [January 26, 2007] 3. Milan Kubr, Management Consulting: A guide to the profession: Fourth Edition Wikipedia Management Consulting [online] available from [January 26, 2007] Read More