Treasurers grapplewith capital allocation issues as cash flows wax and wane with drug approvals,expiring patents and other ups and downs.
There’s nothing likedramatic stock price moves to illustrate the feast or famine nature of revenueand cash flow at life sciences companies that live or die by the success orfailure of clinical trials for drugs or devices. To kick off a discussion onhow this binary reality affects financial strategy, one Life Sciences Treasurers’Peer Group member showed hispeers a chart of his company’s stock dropping fast from the upper left to the lowerright.
Hulk or Bruce Banner? The first-hand account of this company’s binary bind sparked awide-ranging discussion about the challenges of capital allocation andstructure at companies that one day resemble the Incredible Hulk (successfuldrugs coming out of the pipeline, fast growth, high margins) and then revert tobeing a not-so-incredible Bruce Banner (drugs going off patent, sluggishpipelines, flat revenues)—and back again.
The bottom line. As part of financial policy and planning, life sciencescompanies need to account for this duality and then structure their R&Dspending, liability towers and other capital allocation decisions around theseinevitable boom-or-bust periods. Their financial structures must beresilient in the face of binary events.
KPIs to model capital planning andallocation. Given the binary contingency reality and potential growthvolatility, the presenting member asked his peers for key performanceindicators (KPIs) or a quantitative framework to guide capital planning andallocation decisions. While some CFOs like to manage capital planning andcollaboration by feel or instinct, having tangible triggers can help ensureeveryone is aligned. One member’s CFO is a fan of economic value-added(EVA), for example.
The Rubik’s Cube approach.Several treasurers suggested their capital planning and allocationdecisions are akin to twisting a Rubik’s Cube with some of the colored panels alreadyset. For example, the leverage ratio may need to remain at no more than 3x orthere may be a promise to continue increasing the dividend each quarter. Butthen the other rows can be turned to line up the colors. Try starting with whatis sacrosanct and working back.
The working capital calculus. Life sciencescompaniesfacing periods of flat growth have a heightened need to manage their workingcapital efficiently. No wonder several members cited improving working capitalmanagement and effectiveness as top priorities before the meeting. As part ofthe move to cut costs and increase efficiency, one member mentioned movingoperations and personnel to a city in the South where costs are lower than onthe West Coast. And it’s another reason more members want to exploit roboticprocess automation (RPA) solutions to eliminate as many manual processes aspossible. Having technology in place to scale when Hulk-like growthreturns—without adding permanent fixed costs—is also a driver.
Adjust payment schedules. Lifesciences companies have some additional challenges with working capitalbecause, for example, cash is not always generated where it is needed andpublic sector entities tend to pay on a much different (longer) cycle thanthose in the private sector. Enjoying long cycles of high-margin sales that leadto becoming cash-rich, life sciences finance functions may not have an easytime creating a cash or working capital-driven culture where payables does notautomatically pay every big invoice as soon as it comes in the door. Solvingthese working capital challenges is of paramount importance for one guestmember, who said the company’s CFO wants to use treasury to run working capitalefforts for the whole company.