Over the years Finance professionals, whether having gone through business school or as part of their accounting training, have been taught and introduced to various economic concepts and mental models that if applied correctly can help create more value for our organisations and help them be more successful.
These tools and models I refer to are those like risk management, opportunity cost, comparative advantage, Kaizen, variance analysis, customer account profitability, beyond budgeting, balanced scorecards, but many of these ‘useful’ tools are rarely being applied on-the-job or if they are, they’re being done inconsistently or haphazardly.
This is frustrating because as finance professionals we’ve assimilated all these potentially great finance tools and models and we’re not applying or making full use of them. Okay so some of you ask, but does this matter? Well given 9 out of 10 business will fail in the long run (35+ years), or that fewer than half of the Company names that featured on the 2000 list of the Fortune 500 (the world’s 500 largest companies) are still there today then isn’t our answer obvious in those poor numbers, we simply could be doing a better job if we were applying the right tools and mental models to help create value for our businesses.
We may not be successful all the time because of internal politics, market shifts, etc… but imagine if we could start practically applying these tools and models you’d like to think we could go from having 1 out 10 successful businesses to perhaps 2 out of 10, a 100% improvement. So why aren’t we using these tools and models at our disposal or if we using them why aren’t they yielding effective results?
1. We’ve not been shown how to apply them properly.
We’ve struggled to take the knowledge & tools we’ve learned in the classroom and transport them into our workplaces. We’ve not been shown how to develop these tools into the right mental models, so we’ve not been able to simplify and organise the myriad of inputs we get from the world around us into the right value drivers in order to correctly shape and support our thinking, decision making, opinions, values and impacts. Let’s think about it, how many failed businesses implemented budget cycles, or variance analysis or even had balanced scorecards?
And to compound matters because these models have not been correctly applied we don’t get as good a grasp of historical trends or of what is really going on to make effective sense of what we see going on in the numbers.
2. These mental models don’t fit reality
Because if our models are to be constructive and beneficial to us they must connect us to reality as well as improve our ability to assimilate new information in order to update and refine them. When they don’t fit reality, in the worst cases, they can be destructive. You’ve all probably heard when people used to believe that the earth was flat and even though no one had actually been proven to have fallen off the edge of the earth the thought of travelling in certain far off directions was feared and people behaved accordingly.
A major consequence of this flawed the-world-is-flat thinking is that people were held back from making progress and many discoveries and opportunities were delayed until the likes of Christopher Columbus challenged that particular mental model.
How to improve our models
In finance the quality of our models goes on to determine how well we can add value to our organisations, and there are a few things we can do to improve them.
- Be aware of our biases: we must constantly remind ourselves that just because we believe or want a thing to be true does not make it so (i.e. lets not look out for the trend we want to see). Just because we’ve predicted that a proposed price decrease will increase volumes in one of our financial models doesn’t mean we should be looking to report these increased volumes on that product in isolation particularly if it has also caused a cannibalisation on the sales of another product line.
- They must be neither overly complicated nor too simple. In effect we must not be missing key value drivers or secondary consequences. That’s why three-way modelling is key to ensure if we, let’s say, wish to make an investment in headcount to produce more units, how do we expect to see this play out in additional revenues & expenses in the income statement, the inventories and working capital on the balance sheet and the timings of future cash inflows and outflows to ensure the model is water-tight and balanced end to end.
- They should be checked whenever we go get the results we anticipated. We must be open minded to understanding why we missed so we can improve and refine our models so we can help make better decisions in future.
- And finally they must always be challenged and improved even when they’ve been accurate. We need to constantly ask ourselves if we in our own way are thinking and behaving as if the world were indeed flat.
And this last point in particular is why we invite our finance guest mentors on the Strength in the Numbers Show, who share with you their stories on things they’ve found challenging and where they’ve improved so that our finance world becomes less flat and we in turn become a bit more well-rounded from them sharing their hard won lessons. These conversations allow us an opportunity to re-evaluate our own mental models against their practical experiences, and so improve and assimilate new ones for ourselves and enhance the constructive impact we can help make for our organisations.
So how do you keep sure that your mental models and tools are up to date and constructive? Or what has worked for you?
The author Andrew Codd is the producer of the Strength in the Numbers Podcast which aims to create more influential finance professionals worldwide who solve meaningful problems for their organisations and in return have fun, rewarding and successful careers in finance.