There is a saying: “You can’t really understand another person’s experience until you have walked a mile in their shoes”. Knowledge is the information and data acquired by an individual through their experiences and education. Understanding is the mental process which requires thinking and the use of concepts to deal with something at hand. When you know, you are able to identify, label, list, name, and recall data. When you understand, you are able to distinguish, explain, interpret, and summarize data.
I often hear that “my accountant” does not understand my business. They then continue by saying their accountant ‘knows’ what the company does, but does not ‘know’ what’s going on inside the business. Essentially accountants are viewed as a necessary evil, masters of debits and credits that can pull off reports like there is no tomorrow. They usually finish with a statement such as “… and I have no idea on how to read those reports they provided or what they are trying to tell me.”
Understanding What the Numbers Mean in a Business The executives or business owners then ask – what do all these numbers mean? The answers usually come back
“working capital good/bad”,
days sales outstanding good/bad,
months of inventory good/bad,
gross margin good/bad,
debt to equity good/bad,
solvent versus insolvent.
A barrage of terms and ratios are then floated around with a follow up question of “so what does all that mean?” … “How does all this really apply to my business, I mean my core business, and do I need to do anything different?” to which their accountant will probably say the same thing as before but with a different twist or words; but the message is still the same. This may not be the norm, but trust me, I have seen this happen. Quick lesson: you can’t use the term to define the same term.
Let’s face it, as far as the value of financial reporting is concerned, at the end of the day it all comes down to cash in the bank (increasing or decreasing) and how much tax you are going to need to pay. Financial accountants are experts at compiling your yearend statements and calculating how much tax you owe. Licenced Public Accountants (LPA) can provide assurance that the statements fairly reflect the operations. If you owe a bank money or have investors, preparing and presenting “audited” or “reviewed” financial statements is in all likelihood a requirement, something only an LPA can offer. Stakeholders are ultimately concerned with how much cash is being generated by the business and if the company can meet its obligations (legal, regulatory etc.) as they come due. Financial statements allow different parties to communicate key messages about the company using a common language. Investors and bankers use this information to gain more insight into the operations of a company and to make decisions. Make sure you have a professional accountant to help you out (CPA) with these statements as professional oversight during the compilations has value to the owners of the company and to its stakeholders.
One challenge for business owners lies in getting relevant business information to make good business decisions. Relevant business information goes beyond the numbers, and this is where the difference between knowing the business and understanding the business becomes important. To “know the business”, you know how the sales are generated and how revenue is earned, and how orders are processed, stored and shipped out. You are aware that there is a function that deals with post-acquisition or post-delivery support requirements. You identify who your customers and suppliers are and you might understand what they demand of you, and if any special provisions exist. What you may not know are the problems that each of these areas of the business deal with, the errors dealt with, the complaints of customers and suppliers, the inefficiencies created by policies in one area the impact another. To “understand the business” you are able to recognize the relationships between these functions, how they intermingle, and how the impact of change in one area of the business affects another. With an understanding you are then able to formulate and predict future outcomes with a higher probability of success. None of these items are reflected in the books you keep or the statements you read.
If you review the IFAC (International Federation of Accountants) definition of what management accounting is, you begin to realize that the practice covers a lot more than just debits and credits. A strong focus is on performance analysis, planning and decision support.
In terms of value to the organization and the impact that ‘predictive’ activities can have on the organization, I would say that the reliance on management accounting for timely, relevant, accurate, reliable, repeatable and predictable information is a critical success factor to any company. Companies are in the business to make money – period – full stop. Having good people who can supply them with this type of information and insight is mandatory. It is necessary for someone to know what they are talking about, but it is even better to have someone who understands what they are talking about and can link all of this information strategically.
In a company there are many individuals spending money and generating revenue. But how does one determine what is an appropriate spend or not? We entrust experts to assure us the expenditures (capital or otherwise) is required. Often these experts, who are often put into management positions, have their goals and objectives to meet and as a result, have their own agenda when it comes to spending. As executives we trust their judgement; as financial executives we need to trust with validation. There are many competing programs vying for limited resources and ultimately cash. This is where understanding the business excels over knowing the business.
Why Understanding Is More Important Than Knowing Having a person who has worked as an executive in operations, manufacturing, development, marketing and sales, an understanding is created that not all spending is equal and intelligent trade-offs can be made. Executives may know that a dollar spent wisely in design can save twenty dollars later on; executives with deep cross functional experience understand the “why’s” and “how’s” of that spending, thereby offering greater stewardship of company funds. Having this understanding allows for better questioning and not normally taking things at face value.
When it comes time to assess corporate performance, an understanding of the operations can allow for gaining better insights as to why things exceed or fell short of expectations. Understanding versus knowing also allows us to differentiate between Reasons and Excuses. A reason is based in fact that clearly explains why something happened; it has cause and effect; whereas an excuse is the reason given to explain why something was not done that should have been done. Understanding how the company works provides additional insights to be able to ask harder questions to identify what statements are ‘excuses’ or ‘reasonable explanations’ when performance does not meet expectations.
So how does this fit with what a finance executive should know? A basic principle is that activities consume resources. Resources cost companies money. I always say that the quickest way to improve the bottom line is to stop doing stupid things. This is so controllable. Stupid activities waste money, productive activities generate positive cash flow for the business. Stupid activities are justified based upon excuses, productive activities are justified by reasonable explanations. Understanding and insight help executives sort through excuses and reasons quickly.
As financial stewards of the company we are responsible for the financial wellness or well-being of the company. In order to address wellness issues, we need to understand how activities, investments and spending in general impact wellness and be able to recommend corrective action that improves the situation. Looking at financial statements and determining that the company is not healthy is ‘diagnosis’, offering up a course of action that leads to increase health is ‘prescriptive’. Prescriptions given without the proper understanding of the organization and insight into the functions of the organization could become fatal.
If you need help understanding what your financials are telling you in your business, we can provide the assistance you need through a coaching or consulting engagement depending on your requirements. One of our Partners, Rudy Fischer, is a CPA, CMA (Certified Management Accountant), so he can assist you in gaining an understanding of what your financials are currently telling you about your business.
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