Sometimes, I am asked, “How did we get into this mess?” “What did we do wrong?” My standard answer lies in a phenomena that I have seen in one challenged organization after another and the thing that inspired me to pursue a doctorate degree in Healthcare Administration that was focused on Evidence Based Leadership. When an organization becomes challenged, in every case in my experience, there has been a consistent pattern of questionable decision making sometimes spanning years leading up to the transition event.
Organizations that consistently do well have one thing in common. They make consistent, disciplined, evidence based decisions that work out with a high probability of success. Organizations that end up challenged and in transition have an equally consistent pattern of non-evidence based decisions that have a high probability of not turning out well. Everyone makes mistakes. The name of the game is to win more than you lose.
I am used to hearing, “Everything was OK then all of a sudden, we went off the track.” They want to know if it can be fixed.
I always say, “Absolutely.”
The next question is inevitably, “What will it take?”
To which I respond, “One thing,” as I hold up a single finger. Remember the movie City Slickers?
Of course, they want to know what the one thing is to which I reply, “I cannot tell you.”
When they want to know why, I say that if I tell you the ‘one thing’ there will be no further need for me.
After letting them stew for a few minutes, I relent.
The ‘one thing’ is to start making disciplined, evidence based business decisions. That is all. See to it that this happens in your organization and we will never have a chance to work together.
Decision makers have told me, “I understand this concept but I don’t understand all of this finance stuff”. I tell them that is not a problem because I don’t understand much of it myself. A lot of people try to impress others by putting the razzle-dazzle on them. They use big words and arcane concepts in an effort to prove they are smarter than me and to convince me I cannot get where I want to go without their help.
In my opinion, it is easy to make something hard but infinitely more complex to make it simple. I would argue that you do not understand a concept very well yourself if you cannot put it into terms that a lay person can understand. All too often, complicated presentations sound like so much BS to lay people. This is a severe problem if the lay people happen to be members of a Board of Directors. Spouting BS instead of being clear, understandable and transparent has caused more than one executive I know to end up on the job market creating a gig for me in the process. It almost always leads to a loss of credibility even when it is technically correct.
I had finance committee members in one organization express concern about ‘Voodoo arithmetic’ and ‘Cookie Jar Accounting.’ The prior CFO that was very good in my opinion had managed to lose credibility by failing to be sufficiently clear and transparent with the Finance Committee and Board of Directors.
I like to tell my clients that I can teach you everything you need to know about finance in a couple of sentences. This never ceases to galvanize their attention. You mean that you can learn everything you need to know about corporate finance in a couple of sentences? The answer is an emphatic YES. Here we go.
The financial performance of any organization is nothing more or less complicated than the weighted average return on investment of each of its many assets. Collectively this return is generally described alternatively as return on equity or cost of capital. Except for operating expenses, every commitment of funds the organization makes is an investment in an asset other than cash. If the return on this investment is greater than the organization’s cost of capital, the effect of the investment will be to improve the financial performance of the organization. If the return on an incremental investment is lower than the organization’s cost of capital, its effect on operating performance will be detrimental. A series of bad investments will lead any organization into trouble. From a finance perspective, it doesn’t matter what the investment is.
There you have it. Corporate fiance in a few sentences. Everything you need to know to be successful financially and to lead an organization to improved financial and operating results.
Now, I have some questions for you.
Do you know what your cost of capital is?
Do understand how the cost of capital is derived?
When was the last time you considered the effect of what you were planning was going to have on the organization?
When was the last time you got this question in the Board Room?
What did you do the last time you were present when a politically motivated decision or a decision of expediency was being debated?
When was the last time you included in your project plan a mitigation strategy for a proposed investment that was not accretive in its own right?
Have you done a sensitivity analysis to understand the degree to which your project’s assumptions bear on the expected outcome?
Do you understand from your sensitivity analysis the threshold at which you would not recommend that the project go forward?
When was the last time you did an evaluation of asset returns in your existing portfolio to gain a better understanding of which of your investments are accretive and which are not?
Do you understand the difference between return on equity and return on investment? If you want to get fancy, you can undertake a study of the effects and considerations of leverage on return on investment.
I frequently hear executives say that it is the business of the CFO to know all of the ‘finance stuff.’ My response to this is that if you call yourself an executive and you plan to advocate for anything (especially in a Board room) that requires an investment and you do not have a reasonable command of these concepts, you are an idiot.
Someone might read this and conclude incorrectly that this is all about money and not much else, a complaint I have often heard. I have a fair amount of experience working in Catholic healthcare. Every Catholic hospital I have worked in claims to be the one that housed the first nun that uttered the words, “No margin, no mission.” It is about money but it is about more, the mission. Unless the organization is financially healthy, it cannot sustain itself and if it loses the ability to sustain itself, it will find its ability to continue to carry out its mission compromised.
This is original work. I have not seen content of this nature in my extensive dissertation research. This material is copyrighted by me with reproduction prohibited without prior permission. I always note and provide links to supporting documentation for non-original material.