Finance Byte - Week 2 The Sixth Sense

Recap

During week 1, we discussed how finance has a unique vantage point to see :

1. whether a company is adding value?
2. How much value is being added?
3. Is the company adding value in the most efficient way.

Then we explored at a very basic level how finance can help companies at various stages to help survive & thrive in the market.

We grouped finance responsibilities under two categories to :

1. Keep the wheels running
2. Add value

The below visual (shared last week) summarizes the above :

Let us analyze our journey in finance from the first step

The First Step

I'll start this week with the below quotes from SecretCFO -

You need to build enough commercial savvy understanding of your business & wider awareness to understand the PESTLE factors that could influence your business

Make sure you have your finger on the pulse of what is happening in the economy

(Source : here)

Now, how do we as finance professionals develop this mindset? Well, most of us do not when we start & I believe we cannot start with this mindset. As with any profession, it is a journey from the bottom of this mountain which starts with accounting, audit & corporate finance. We walk up, learn & accumulate knowledge along the way.

The Journey

A typical accountant journey starts with an internship in any accounting or audit firm (as we used to call it "articleship" in India). We work as interns in an accounting / audit firm going for client work & gain experience along with preparing for the exams. In that journey, a typical assignment involves

1. Checking transactions
2. Analyzing general ledgers
3. Correlating transactions with ledgers to verify correctness in the process of booking transactions.
4. Move up to the trial balance
5. From the trial balance, prepare the
   1. Balance Sheet &
   2. Income Statement
   3. And then from the above, cash flow statements

This is like the base camp of Mount Everest from where the expedition to the peak actually starts.

Now, in case the assignment is to audit financial statements, we trace the transactions from base numbers to the trial balance & then to the financial statements. We also correlate the numbers with schedules which form part of the notes to financial statements.

Another key point is that for companies (subject to regulatory requirements), the financial statements should comply with a set of standards called IFRS or International Financial Reporting Standards. (In the US, the equivalent standards is called US GAAP or Generally Accepted Accounting Principles). This is to ensure consistency in treatment of various items in the financial statements across companies & over period of time so that they are comparable for investors & regulators.

Once we qualify & join a corporate finance team in any company, this is what we do day in & day out.

Now, you get the idea why we are so focused on numbers as part of our training & daily work. But this rigorous training that we go through with numbers, matching schedules with trial balance, with other schedules, the main statements & notes, compliance with standards etc is critical. Why?

The Sixth Sense

Because, like I mentioned last week, this shows strong control over the flow of data from the transaction level to the financial statements & notes. These numbers form the basis for investor disclosures, regulatory reports, tax filings etc.

Investors look at these numbers to decide whether to buy, hold or sell their investments in the company.

These numbers also form the basis of internal KPIs (Key Performance Indicators) to check whether the company is on track to achieve the milestones set by the Strategy. If not, the leadership team decides the corrective action.

Hence, it is very important that we, as financial professionals, develop the sixth sense for numbers. In fact, after a couple of years experience generating, checking & correlating numbers with different data points, we develop the muscle memory for numbers . Now, that doesn't mean we develop any mental super powers. It just means through experience, we can identify whether the numbers make sense or not in line with our understanding of the company's activities & the external environment.

But the problem is, most of us end up at the accounting & reporting stage & don't move forward. Why?

Because the reporting requirements are onerous. There are periodical reports - daily, weekly, monthly, quarterly, yearly etc. So, most of our time is spent generating reports, preparing dashboards, dealing with auditors, regulators & when we come to an end of one reporting period, the preparation for the next one invariably starts. Why?

Because in most organizations, the processes within finance departments are not optimized for efficient & timely reporting. It starts from

1. Issues in data
2. Issues in reporting software. Excel is king!!!
3. Issues in staffing (understaffed finance department, lack of efficient systems, complicated chart of accounts etc)

Now, with digital transformation percolating across organizations, any & every activity has a financial impact & it is the finance department which has to bear the brunt of any implementation inefficiencies, irrespective of the department where it is implemented or even within finance.

This focus on generating reports within deadlines is the only thing that drives finance team in any entity. This is what results in the ingrained mentality of a typical corporate finance professional of only focusing on the reports & not looking beyond the numbers.

The lack of ability to move forward beyond the numbers causes many of us to get stuck in accounting with a resistance to understand what happens beyond the numbers.

The only exception is if some of us end up in Financial Planning & Analysis or Investment Banking where the work itself involves analyzing internal variables impacting a company & how the company performs against the backdrop of industry & macro economic variables.

Now, is this something wrong? Well, it's not nice that we get stuck in one place professionally or personally. We have to move forward & improve. When we provide the Executive Leadership team with a budget variance, we have to give context behind that variance & not just the variance. What does this mean?

This means understanding:

1. What do these reports prepared so meticulously convey beyond the numbers?
2. What do the end users of these reports look for?
3. What decisions are being taken using these reports?
4. Are there any additional information that can be provided which could help the end users improve their decisions?

Then we take take it up a level by understanding

1. What are the drivers behind the numbers?
2. How can we improve the required performance indicators to move it in the right direction?
3. What are the risks which can impact achievement of the performance indicators?
4. How can these risks be mitigated?
5. How can we incorporate risk into the numbers to improve decision making?

Then we use the above to actually help the leadership team to drive strategy since (as I mentioned last week), finance is the only department which has an amazing vantage point to see if the company is on the right path to achieve it's strategy or not & if not, does the corrective action make sense in the current market & economic conditions?

But for that, we have to come out of the number slumber & start looking beyond the horizon to see the drivers & risks behind those numbers.

How do we do that? But first, let us start our journey from the bottom.